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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
(AMENDMENT NO. 1)
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-22581
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STAR TELECOMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 77-0362681
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification
No.)
223 EAST DE LA GUERRA STREET, 93101
SANTA BARBARA, CALIFORNIA (Zip code)
(Address of principal executive offices)
</TABLE>
(805) 899-1962
(Registrant's telephone no., including area code)
Securities registered pursuant to Section 12(b) of the Act: Common Stock, par
value $0.001 per share
Name of each exchange on which registered: Nasdaq National Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES _X_ NO ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the Common Stock of the Registrant held by
non-affiliates of the Registrant on March 16, 1998, based on the average bid and
asked prices for the Common Stock as reported by Nasdaq was approximately
$438,892,650.
The number of shares of the Registrant's Common Stock outstanding as of
March 16, 1998 was approximately 35,804,000 shares.
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The undersigned Registrant hereby amends the following items of its Annual
Report on Form 10-K for the fiscal year ended December 31, 1997, as set forth
below:
PART I
ITEM 1. BUSINESS.
THIS ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
(THE "FORM 10-K") CONTAINS "FORWARD-LOOKING STATEMENTS," AS DEFINED UNDER
SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT") AND
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE
ACT"). FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN HISTORICAL
INFORMATION OR STATEMENTS OF CURRENT CONDITION AND RELATE TO FUTURE EVENTS OR
THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY. SOME FORWARD-LOOKING STATEMENTS
MAY BE IDENTIFIED BY USE OF SUCH TERMS AS "BELIEVES," "ANTICIPATES," "INTENDS"
OR "EXPECTS." THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE
RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER
AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. UNLESS OTHERWISE
INDICATED, THE INFORMATION IN THIS FORM 10-K GIVES EFFECT TO A 2.05-FOR-1 STOCK
SPLIT PAYABLE IN THE FORM OF A STOCK DIVIDEND TO THE HOLDERS OF ALL SHARES OF
COMMON STOCK OUTSTANDING ON FEBRUARY 20, 1998 WITH THE PAYMENT OF 1.05 SHARES
FOR EACH SUCH OUTSTANDING SHARE OF COMMON STOCK (THE "STOCK SPLIT").
OVERVIEW
STAR Telecommunications, Inc. ("STAR" or the "Company") is an emerging
multinational carrier focused primarily on the international long distance
market. The Company offers highly reliable, low-cost switched voice services on
a wholesale basis, primarily to U.S.-based long distance carriers. STAR provides
international long distance service to approximately 220 foreign countries
through a flexible network comprised of various foreign termination
relationships, international gateway switches, leased and owned transmission
facilities and resale arrangements with long distance providers. The Company has
grown its revenues rapidly by capitalizing on the deregulation of international
telecommunications markets, combining sophisticated information systems with
flexible routing and leveraging management's industry expertise. STAR has
increased its revenues from $46.3 million in 1995 to $376.2 million in 1997.
INDUSTRY BACKGROUND
The international long distance telecommunications services industry
consists of all transmissions of voice and data that originate in one country
and terminate in another. This industry is undergoing a period of fundamental
change which has resulted in substantial growth in international
telecommunications traffic. According to industry sources, worldwide gross
revenues for providers of international telephone service were over $60 billion
in 1996 and the volume of international traffic on the public telephone network
is expected to grow at a compound annual growth rate of approximately 13% from
1996 through the year 2000.
From the standpoint of U.S.-based long distance providers, the industry can
be divided into two major segments: the U.S. international market, consisting of
all international calls billed in the U.S., and the overseas market, consisting
of all international calls billed in countries other than the U.S. The U.S.
international market has experienced substantial growth in recent years, with
gross revenues from international long distance services rising from
approximately $8.5 billion in 1990 to approximately $14.9 billion in 1996,
according to Federal Communications Commission ("FCC") data.
The Company believes that a number of trends in the international
telecommunications market will continue to drive growth in international
traffic, including:
- continuing deregulation and privatization of telecommunications markets;
- pressure to reduce international outbound long distance rates paid by end
users driven by increased competition in newly deregulated global markets;
- the dramatic increase in the availability of telephones and the number of
access lines in service around the world;
- the increasing globalization of commerce, trade and travel;
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- the proliferation of communications devices such as faxes, cellular
telephones, pagers and data communications devices;
- increasing demand for data transmission services, including the Internet;
and
- the increased utilization of high quality digital undersea cable and
resulting expansion of bandwidth availability.
THE DEVELOPMENT OF THE U.S. AND OVERSEAS MARKETS
The 1984 deregulation of the U.S. telecommunications industry enabled the
emergence of a number of new long distance companies in the U.S. Today, there
are over 500 U.S. long distance companies, most of which are small or
medium-sized companies. In order to be successful, these small and medium-sized
companies need to offer their customers a full range of services, including
international long distance. However, most of these carriers do not have the
critical mass to receive volume discounts on international traffic from the
larger facilities-based carriers such as AT&T Corp. ("AT&T"), MCI Communications
Corp. ("MCI") and Sprint Corporation ("Sprint"). In addition, these small and
medium-sized companies generally have only limited capital resources to invest
in international facilities. New international carriers such as STAR emerged to
take advantage of this demand for less expensive international bandwidth. These
emerging multinational carriers acted as aggregators of international traffic
for smaller carriers, taking advantage of larger volumes to obtain volume
discounts on international routes (resale traffic), or investing in facilities
when volume on particular routes justify such investments. Over time, as these
emerging international carriers became established and created high quality
networks, they began to carry overflow traffic from the larger long distance
providers seeking lower rates on certain routes.
Deregulation and privatization have also allowed new long distance providers
to emerge in foreign markets. By eroding the traditional monopolies held by
single national providers, many of which are wholly or partially government
owned, such as Post Telegraph & Telephone operators ("PTTs"), deregulation is
providing U.S.-based providers the opportunity to negotiate more favorable
agreements with PTTs and emerging foreign providers. In addition, deregulation
in certain foreign countries is enabling U.S.-based providers to establish local
switching and transmission facilities in order to terminate their own traffic
and begin to carry international long distance traffic originated in that
country. STAR believes that growth of traffic originated in markets outside of
the U.S. will be higher than the growth in traffic originated within the U.S.
due to recent deregulation in many foreign markets, relative economic growth
rates and increasing access to telecommunications facilities in emerging
markets.
INTERNATIONAL SWITCHED LONG DISTANCE SERVICES
International switched long distance services are provided through switching
and transmission facilities that automatically route calls to circuits based
upon a predetermined set of routing criteria. The call typically originates on a
local exchange carrier's network and is transported to the caller's domestic
long distance carrier. The domestic long distance provider then carries the call
to an international gateway switch. An international long distance provider
picks up the call at its gateway and sends it directly or through one or more
other long distance providers to a corresponding gateway switch operated in the
country of destination. Once the traffic reaches the country of destination, it
is then routed to the party being called though that country's domestic
telephone network.
International long distance providers can generally be categorized by their
ownership and use of switches and transmission facilities. The largest U.S.
carriers, such as AT&T, MCI and Sprint, primarily utilize owned transmission
facilities and generally use other long distance providers to carry their
overflow traffic. Since only very large carriers have transmission facilities
that cover the over 200 countries to which major long distance providers
generally offer service, a significantly larger group of long distance providers
own and operate their own switches but either rely solely on resale agreements
with other long distance carriers to terminate their traffic or use a
combination of resale agreements and owned facilities in order to terminate
their traffic as shown below:
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[THIRD PARTY RESALE GRAPHIC]
OPERATING AGREEMENTS. Under traditional operating agreements, international
long distance traffic is exchanged under bilateral agreements between
international long distance providers in two countries. Operating agreements
provide for the termination of traffic in, and return traffic to, the
international long distance providers' respective countries at a standard
"accounting rate" with that international provider. Under a traditional
operating agreement, the international long distance provider that originates
more traffic compensates the long distance provider in the other country by
paying a net amount based on the difference between minutes sent and minutes
received and the settlement rate, which is generally one-half of the accounting
rate.
Under a typical operating agreement both carriers jointly own the
transmission facilities between two countries. A carrier gains ownership rights
in a digital fiber optic cable by purchasing direct ownership in a particular
cable prior to the time the cable is placed in service, acquiring an
"Indefeasible Right of Use" ("IRU") in a previously installed cable, or by
leasing or obtaining capacity from another long distance provider that either
has direct ownership or IRUs in the cable. In situations where a long distance
provider has sufficiently high traffic volume, routing calls across directly
owned or IRU cable is generally more cost-effective on a per call basis than the
use of short-term variable capacity arrangements with other long distance
providers or leased cable. However, direct ownership and acquisition of IRUs
require a company to make an initial investment of its capital based on
anticipated usage.
TRANSIT ARRANGEMENTS. In addition to utilizing an operating agreement to
terminate traffic delivered from one country directly to another, an
international long distance provider may enter into transit arrangements
pursuant to which a long distance provider in an intermediate country carries
the traffic to a country of destination. Such transit arrangements involve
agreement among the providers in all the countries involved and are generally
used for overflow traffic or where a direct circuit is unavailable or not volume
justified.
RESALE ARRANGEMENTS. Resale arrangements typically involve the wholesale
purchase and sale of transmission and termination services between two long
distance providers on a variable, per minute basis. The resale of capacity,
which was first permitted in the U.S. market in the 1980s enabled the emergence
of new international long distance providers that rely at least in part on
capacity acquired on a wholesale basis from other long distance providers.
International long distance calls may be routed through a facilities-based
carrier with excess capacity, or through multiple long distance resellers
between the originating long distance provider and the facilities-based carrier
that ultimately terminates the traffic. Resale arrangements set per minute
prices for different routes, which may be guaranteed for a set time period or
subject to fluctuation following notice. The resale market for international
capacity is constantly changing, as new long distance resellers emerge and
existing providers respond to fluctuating costs and competitive
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pressures. In order to be able to effectively manage costs when utilizing resale
arrangements, long distance providers need timely access to changing market data
and must quickly react to changes in costs through pricing adjustments or
routing decisions.
ALTERNATIVE TERMINATION ARRANGEMENTS. As the international
telecommunications market has become deregulated, service providers have
developed alternative arrangements to reduce their termination costs by, for
example, routing traffic via third countries to obtain lower settlement rates or
using international private line facilities to bypass the settlement rates
applicable to traffic routed over the public switched telephone network
("PSTN"). These arrangements include International Simple Resale ("ISR"),
traffic refiling and the acquisition of transmission and switching facilities in
foreign countries so as to self-correspond. Refiling of traffic takes advantage
of disparities in settlement rates between different countries. An originating
operator typically refiles traffic by sending it first to a third country that
enjoys lower settlement rates with the destination country where upon it is
forwarded or refiled to the destination country thereby resulting in a lower
overall termination cost. The difference between transit and refiling is that,
with respect to transit, the operator in the destination country typically has a
direct relationship with the originating operator and is aware of the
arrangement, while with refiling, the operator in the destination country
typically is not aware that it is terminating refiled traffic originated in
another country. While the United States has taken no position with respect to
whether refile comports with international regulation, refile is illegal in many
countries. With ISR, a long distance provider completely bypasses the settlement
system by connecting an international private line ("IPL") to the PSTN on one or
both ends. While ISR currently is only sanctioned by U.S. and other regulatory
authorities on some routes, ISR services are increasing and are expected to
expand significantly as deregulation of the international telecommunications
market continues. In addition, new market access agreements, such as the World
Trade Organization ("WTO") Basic Telecommunications Agreement (the "WTO
Agreement"), have made it possible for many international service providers to
establish their own transmission and switching facilities in certain foreign
countries, enabling them to self-correspond and directly terminate traffic. See
"--Government Regulation."
The highly competitive and rapidly changing international telecommunications
market has created a significant opportunity for carriers that can offer high
quality, low cost international long distance service. Deregulation,
privatization, the expansion of the resale market and other trends influencing
the international telecommunications market are driving decreased termination
costs, a proliferation of routing options, and increased competition. Successful
companies among both the emerging and established international long distance
companies will need to aggregate enough traffic to lower costs of both
facilities-based or resale opportunities, maintain systems which enable analysis
of multiple routing options, invest in facilities and switches and remain
flexible enough to locate and route traffic through the most advantageous
routes.
THE STAR APPROACH
STAR is an emerging multinational carrier focused primarily on the
international long distance market. The Company offers highly reliable, low-cost
switched voice services on a wholesale basis, primarily to U.S.-based long
distance carriers. STAR provides international long distance service to
approximately 220 foreign countries through a flexible network comprised of
various foreign termination relationships, international gateway switches,
leased and owned transmission facilities and resale arrangements with long
distance providers. The Company has grown its revenues rapidly by capitalizing
on the deregulation of international telecommunications markets, combining
sophisticated information systems with flexible routing and leveraging
management's industry expertise.
STAR markets its services to large global carriers seeking lower rates and
high quality overflow capacity, as well as to small and medium-sized long
distance companies that do not have the critical mass to invest in their own
international transmission facilities or to obtain volume discounts from the
larger facilities-based carriers. During the fourth quarter of 1997, the Company
provided switched international
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long distance services to 105 customers and currently provides these services to
nine of the top forty global carriers. The Company has also recently focused on
building a customer base overseas, particularly in Europe, and has opened
offices in Dusseldorf, Frankfurt, Hamburg and Munich, Germany and London,
England. In addition, STAR has begun to market its international long distance
services directly to certain commercial customers in the U.S. and overseas.
STRATEGY
The Company's objective is to be a leading provider of highly reliable,
low-cost switched international long distance services on a wholesale basis to
U.S. and foreign-based telecommunications companies, as well as on a retail
basis to commercial customers. Key elements of the Company's strategy include
the following:
EXPAND SWITCHING AND TRANSMISSION FACILITIES. The Company is continuing to
pursue a flexible approach to expanding and enhancing its network facilities by
investing in both switching and transmission facilities where traffic volumes
justify such investments. The Company has expanded its international gateway
switching facilities through the addition of a facility in Dallas and plans to
put into service in 1998 switches in Atlanta, Chicago, Miami and Seattle;
Dusseldorf, Frankfurt, Hamburg and Munich, Germany; Paris, France; and Tokyo,
Japan. The Company's international gateway switch in London, England went into
service in April 1997 and four switches in Germany are expected to be
operational in the second quarter of 1998. In addition, the Company is planning
to install a network of switches in selected other European and Asian cities.
CAPITALIZE ON PROJECTED INTERNATIONAL LONG DISTANCE GROWTH. The Company
believes that the international long distance market provides attractive
opportunities due to its higher revenue and profit per minute, and greater
projected growth rate as compared to the domestic long distance market. The
Company targets international markets with high volumes of traffic, relatively
high rates per minute and prospects for deregulation and privatization. The
Company believes that the ongoing trend toward deregulation and privatization
will create new opportunities for the Company in international markets. Although
the Company has focused to date primarily on providing services for U.S.-based
long distance providers, the Company also intends to expand the international
long distance services it offers to foreign-based long distance providers.
LEVERAGE TRAFFIC VOLUME TO REDUCE COSTS. The Company continues to focus on
building its volume of international long distance traffic. Higher traffic
volumes strengthen the Company's negotiating position with vendors, customers
and potential foreign partners, which allows the Company to lower its costs of
service. In addition, higher traffic volumes on particular routes allow the
Company to lower its cost of services on these routes by transitioning from
acquiring capacity on a variable cost per minute basis to fixed cost
arrangements such as longer-term capacity agreements with major carriers,
long-term leases and ownership of facilities.
LEVERAGE INFORMATION SYSTEMS AND SWITCHING CAPABILITIES. The Company
leverages its sophisticated information systems to analyze its routing
alternatives, and select the most cost-effective routing from among the Company
owned facilities, network of resale arrangements with other long distance
providers, operating agreements and alternative termination relationships. The
Company has invested significant resources in the development of software to
track specific usage information by customer and revenue and cost information on
specific routes on a daily basis. The Company's information systems are critical
components in managing its customer and vendor relationships, routing traffic to
the most cost-effective alternative, and targeting its marketing efforts.
MAINTAIN HIGH QUALITY. The Company believes that reliability, call
completion rates, voice quality, rapid set up time and a high level of customer
and technical support are key factors evaluated by U.S. and foreign-based
telecommunications companies and large corporate customers in selecting a
carrier for their
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international traffic. The Company's state-of-the-art switching equipment is
fully compliant with international C-7 and domestic SS-7 signaling standards.
STAR strives to provide a consistently high level of customer and technical
support and has technical support personnel at its switching facilities 24 hours
per day, seven days per week to assist its customers and to continually monitor
network operations.
EXPAND INTO COMMERCIAL MARKET. The Company plans to expand into niche
commercial markets in the U.S. and in other deregulating countries where it
believes it can leverage its international network and where the customer base
has a significant international calling pattern. The Company recently acquired
L.D. Services, Inc. ("LDS") and intends to acquire United Digital Network, Inc.
("UDN"). The Company is using the LDS telemarketing sales force to target small
commercial customers in ethnic markets to increase traffic to Mexico and Latin
America. Additionally, STAR intends to use UDN's network of independent sales
agents to target medium-sized commercial customers with a demand for
international calling services at competitive rates. Finally, the Company plans
to use its direct sales forces to target larger commercial customers,
concentrating at first on potential customers in Los Angeles and New York. With
respect to the offering of commercial services abroad, the Company initially
intends to focus on Germany, the U.K. and selected European cities where
competition for commercial customers is less mature.
GROWTH THROUGH ACQUISITIONS. The Company actively pursues opportunities to
enhance its business through strategic and synergistic acquisitions. These
acquisitions may focus on entering new territories, enlarging the Company's
presence in an existing territory, adding capacity or expanding into new market
segments, such as the commercial market. In addition to expanding its revenue
base, the Company plans to realize operating efficiencies by integrating
newly-acquired operations into the Company's billing, tracking and other
systems. On November 30, 1997, the Company acquired LDS, a long distance
provider focusing on small commercial customers throughout the United States,
for approximately 849,000 shares of Common Stock. On March 10, 1998, the Company
acquired T-One Corp. ("T-One"), an international wholesale long distance
provider, for 1,353,000 shares of Common Stock. On November 19, 1997, the
Company entered into an agreement to acquire UDN, a commercial long distance
provider. The acquisition of UDN is subject to approval by UDN's stockholders
and to various regulatory approvals. Assuming the receipt of all necessary
approvals, STAR expects to consummate the UDN acquisition in the second quarter
of 1998 for approximately 800,000 shares of Common Stock. Each of these
transactions has been, or will be, accounted for as a pooling of interests.
NETWORK
The Company provides international long distance services to approximately
220 foreign countries through a flexible, switched-based network consisting of
resale arrangements with other long distance providers, various foreign
termination relationships, international gateway switches and leased and owned
transmission facilities. The Company's network employs state-of-the-art digital
switching and transmission technologies and is supported by comprehensive
monitoring and technical support personnel. The Company's switching facilities
are staffed 24 hours per day, seven days per week.
TERMINATION ARRANGEMENTS
The Company seeks to retain flexibility and maximize its termination
opportunities by utilizing a continuously changing mix of routing alternatives,
including resale arrangements, operating agreements and other advantageous
termination arrangements. This diversified approach is intended to enable the
Company to take advantage of the rapidly evolving international
telecommunications market in order to provide low-cost international long
distance service to its customers.
STAR utilizes resale arrangements to provide it with multiple options for
routing traffic through its switches to each destination country. Traffic under
resale arrangements typically terminates pursuant to a third party's
correspondent relationships. The Company purchased capacity from 57 vendors in
1997. A substantial portion of this capacity is obtained on a variable, per
minute and short-term basis, subjecting the Company to the possibility of
unanticipated price increases and service cancellations. The Company's
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contracts with its vendors provide that rates may fluctuate, with rate change
notice periods varying from five days to one year, with certain of the Company's
longer term arrangements requiring STAR to make minimum usage commitments in
order to achieve additional volume discounts. As a result of deregulation and
competition in the international telecommunications market, the pricing of
termination services varies by carrier depending on such factors as call traffic
and time of day. Since the Company does not typically enter into long-term
contracts with these providers, pricing can change significantly over short
periods of time. The Company's proprietary information systems enable the
Company to track the pricing variations in the international telecommunications
market on a daily basis, allowing the Company's management to locate and reroute
traffic to the most cost-effective alternatives. See "Risk Factors--Operating
Results Subject to Significant Fluctuations."
The Company currently has operating agreements with carriers in a number of
countries and is in the process of negotiating additional operating agreements
for other countries. The Company has been and will continue to be selective in
entering into operating agreements. The Company also has agreements with
international providers of long distance services for termination of traffic
that the Company routes over its network to such countries. The Company
currently has such termination arrangements with several carriers in a number of
countries, and STAR is in the process of expanding its coverage of such
countries and entering into similar arrangements in additional countries. The
FCC or foreign regulatory agencies may take the view that certain of the
Company's termination arrangements do not comply with current rules and policies
applicable to international settlements, such as current ISR rules. To the
extent that the revenue generated under such arrangements becomes a significant
portion of overall revenue, the loss of such arrangements, whether as a result
of regulatory actions or otherwise, could have a material adverse effect on the
Company's business, operating results and financial condition. In addition, the
FCC could impose sanctions on the Company, including forfeitures, if certain of
the Company's arrangements are found to be inconsistent with FCC rules. See
"--Government Regulation," "Risk Factors--Risks of International
Telecommunications Business," and "--Potential Adverse Effects of Government
Regulation."
SWITCHES AND TRANSMISSION FACILITIES
International long distance traffic to and from the U.S. is generally
transmitted through an international gateway switching facility across undersea
digital fiber optic cable or via satellite to a termination point. International
gateway switches are digital computerized routing facilities that receive calls,
route calls through transmission lines to their destination and record
information about the source, destination and duration of calls. STAR's global
network facilities include both international gateway switches and undersea
digital fiber optic cable.
The Company currently operates international gateway switches in New York,
Los Angeles, Dallas and London, England. In 1998, the Company plans to put into
service international gateway switches in Atlanta, Chicago, Miami and Seattle;
Dusseldorf, Frankfurt, Hamburg and Munich, Germany; Paris, France; and Tokyo,
Japan. The Company considers any of its switches to be international gateway
switches if the Company can route international calls across such switch.
STAR's switching facilities are linked to a proprietary reporting system,
which the Company believes provides it with a competitive advantage by
permitting management on a real-time basis to determine the most cost-effective
termination alternatives, monitor customer usage and manage gross margins by
route. The Company has installed multiple redundancies into its switching
facilities to decrease the risk of a network failure. For example, the Company
employs both battery and generator power back-up and has installed hardware that
automatically shifts the system to auxiliary power during a power outage, rather
than relying on manual override. STAR is in the process of adding a network
control center in its Los Angeles facility, which is expected to be completed in
1998.
The Company currently holds ownership positions in a number of digital
undersea fiber optic cables, and has recently added capacity on the TPC-5
undersea fiber optic cable system and has entered into
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commitments to acquire transmission capacity on three additional undersea fiber
optic cable systems, Gemini, AC-1 and China-US. The Company plans to increase
its investment in direct and IRU ownership of cable in situations where the
Company enters into operating agreements and in other situations in which it
determines that such an investment would enhance operating efficiency or reduce
transmission costs.
Through its acquisitions of T-One and UDN, STAR has acquired, or will
acquire, additional switching and transmission facilities. By acquiring T-One,
the Company has added a switch located in the same building as the Company's New
York international gateway switch and has added a number of operating agreements
to countries in Africa and the Middle East, among other locations. In addition,
T-One owns capacity on certain cable and satellite systems. Upon consummation of
the acquisition of UDN, the Company will acquire a switch located in the same
building as the Company's Dallas switch. The Company plans to integrate these
facilities into its existing network.
SALES AND MARKETING
The Company markets its services on a wholesale basis to other
telecommunications companies through its experienced direct sales force and
marketing/account management team who leverage the long-term industry
relationships of the Company's senior management. The Company reaches its
customers primarily through domestic and international trade shows and through
relationships gained from years of experience in the telecommunications
industry. The Company had 20 direct sales and marketing employees and over 145
telemarketing representatives as of March 1, 1998.
In the wholesale market, the Company's sales and marketing employees utilize
the extensive, customer specific usage reports and network utilization data
generated by the Company's sophisticated information systems to effectively
negotiate agreements with customers and prospective customers and to rapidly
respond to changing market conditions. The Company believes that it has been
able to compete more effectively as a result of the personalized service and
ongoing senior management-level attention that is given to each customer.
In connection with the Company's expansion into the commercial market, the
Company expects to target small commercial customers through LDS' existing
telemarketing operation, deliver services to medium-sized commercial customers
through UDN's network of independent sales agents and utilize a direct sales
force to approach larger commercial accounts. Establishment of a sales force
capable of effectively expanding the Company's services into the commercial
market can be expected to require substantial efforts and management and
financial resources and may increase the Company's operating costs. See "Risk
Factors--Risks Associated with Growth of Telecommunications Network and Customer
Base."
INFORMATION AND BILLING SYSTEMS
The Company's operations use advanced information systems including call
data collection and call data storage linked to a proprietary reporting system.
The Company also maintains redundant billing systems for rapid and accurate
customer billing. STAR's switching facilities are linked to a proprietary
reporting system, which the Company believes provides it with a competitive
advantage by permitting management on a real-time basis to determine the most
cost-effective termination alternatives, monitor customer usage and manage gross
margins by route. The Company's systems also enable it to ensure accurate and
timely billing and to reduce routing errors. As the Company's systems were
designed for the wholesale marketplace, the Company is currently in the process
of modifying its systems in anticipation of its entrance into the commercial
marketplace.
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The Company's proprietary reporting software compiles call, price and cost
data into a variety of reports which the Company can use to re-program its
routes on a real-time basis. The Company's reporting software can generate the
following reports as needed:
- customer usage, detailing usage by country and by time period within
country, in order to track sales and rapidly respond to any loss of
traffic from a particular customer;
- country usage, subtotaled by vendor or customer, which assists the Company
with route and network planning;
- vendor rates, through an audit report that allows management to determine
at a glance which vendors have the lowest rates for a particular country
in a particular time period;
- vendor usage by minute, enabling the Company to verify and audit vendor
bills;
- dollarized vendor usage to calculate the monetary value of minutes passed
to the Company's vendors, which assists with calculating operating margin
when used in connection with the customer reports;
- loss reports used to rapidly highlight routing alternatives that are
operating at a loss as well as identifying routes experiencing substantial
overflow; and
- LATA (Domestic Call Area) reporting by originating and terminating LATA,
allowing for accurate Local Exchange charge audits, and protecting from
Local Exchange overcharging.
STAR has built multiple redundancies into its billing and call data
collections systems. Nine call collector computers receive call information in
real-time, immediately duplicating data, sending one copy to billing, while the
other copy is used for customer service internally and for traffic analysis.
STAR maintains two independent and redundant billing systems in order to both
verify billing internally and to ensure that bills are sent out on a timely
basis. All of the call data, and resulting billing data, are continuously backed
up on tape drives and redundant storage devices, and are regularly transported
to an off-site safe location.
COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. The Company's competitors in the international
wholesale switched long distance market include large, facilities-based
multinational corporations and PTTs, smaller facilities-based providers in the
U.S. and overseas that have emerged as a result of deregulation, switched-based
resellers of international long distance services and international joint
ventures and alliances among such companies. International wholesale switched
long distance providers compete on the basis of price, customer service,
transmission quality, breadth of service offerings and value-added services. The
Company also competes abroad with a number of dominant telecommunications
operators that previously held various monopolies established by law over the
telecommunications traffic in their countries. See "Risk Factors--Significant
Competition." Additionally, the telecommunications industry is in a period of
rapid technological evolution, marked by the introduction of competitive new
product and service offerings, such as the utilization of the Internet for
international voice and data communications. The Company is unable to predict
which of many possible future product and service offerings will be important to
maintain its competitive position or what expenditures will be required to
develop and provide such products and services. The Company believes that it
competes favorably on the basis of price, transmission quality and customer
service. The number of the Company's competitors is likely to increase as a
result of the new competitive opportunities created by the WTO Agreement.
Further, under the terms of the WTO Agreement, the United States and the other
68 countries participating in the Agreement have committed to open their
telecommunications markets to competition, and foreign ownership and adopt
measures to protect against anticompetitive behavior, effective starting on
February 5, 1998. As a result, the Company believes that competition will
continue to
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increase, placing downward pressure on prices. Such pressure could adversely
affect the Company's gross margins if the Company is not able to reduce its
costs commensurate with such price reductions.
COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES AND ALLIANCES. A
majority of the U.S.-based international telecommunications services revenue is
currently generated by AT&T, MCI and Sprint. The Company also competes with
WorldCom, Inc. ("WorldCom"), Pacific Gateway Exchange, Inc. and other U.S.-based
and foreign long distance providers, including the Regional Bell Operating
Companies ("RBOCs"), which presently have FCC authority to resell and terminate
international telecommunication services. Many of these companies have
considerably greater financial and other resources and more extensive domestic
and international communications networks than the Company. The Company's
business would be materially adversely affected to the extent that a significant
number of such customers limit or cease doing business with the Company for
competitive or other reasons. Consolidation in the telecommunications industry
could not only create even larger competitors with greater financial and other
resources, but could also adversely affect the Company by reducing the number of
potential customers for the Company's services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty, with
commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to compete successfully in the commercial
market.
GOVERNMENT REGULATION
The Company's U.S. interstate and international telecommunications service
offerings generally are subject to the regulatory jurisdiction of the FCC.
Certain telecommunication services offered by the Company in the U.S. may also
be subject to the jurisdiction of state regulatory authorities, commonly known
as public utility commissions ("PUCs"). The Company's telecommunications service
offerings outside the U.S. are also generally subject to regulation by national
regulatory authorities. In addition, U.S. and foreign regulatory authorities may
affect the Company's international service offerings as a result of the
termination or transit arrangements associated therewith. U.S. or foreign
regulatory authorities may take actions or adopt regulatory requirements which
could adversely affect the Company. See "Risk Factors--Potential Adverse Effect
of Government Regulation."
U.S. REGULATION
The Company's business is subject to various U.S. and foreign laws,
regulations, agency actions and court decisions. The Company's U.S.
international telecommunications service offerings are subject to regulation by
the FCC. The FCC requires international carriers to obtain authorization under
Section 214 of the Communications Act of 1934, as amended (the "Communications
Act") prior to acquiring international facilities by purchase or lease, or
providing international service to the public. Prior FCC approval is also
required to transfer control of a certificated carrier. The Company is also
subject to FCC policies and rules that regulate the manner in which
international telecommunication services may be provided, including, for
instance, the circumstances under which a carrier may provide international
switched services using IPL facilities and under which it may route traffic
through third countries to or from its final destination.
The Communications Act and the FCC's rules and policies also impose certain
other obligations on carriers providing international telecommunication
services. These include the obligation to file at the FCC and to maintain
tariffs containing the rates, terms and conditions applicable to their services;
to file certain reports regarding international traffic and facilities; to file
certain contracts with correspondent carriers; to disclose affiliations with
foreign carriers and significant foreign ownership interests; to pay certain
regulatory fees based, among other things, upon the carrier's revenues and
ownership of international transmission capacity.
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INTERNATIONAL SERVICES. FCC rules require the Company to obtain prior FCC
authorization to acquire and operate international communication circuits in
satellites and undersea fiber optic cables; similar FCC authority is required
for the Company to resell such capacity. The Company holds both facilities-based
and resale international authorizations, including a "global" authorization that
provides broad authority to offer switched and private line international
services. The Company has filed tariffs for international services with the FCC.
FCC INTERNATIONAL PRIVATE LINE RESALE POLICY. The FCC's IPL resale policy
limits the conditions under which a carrier may connect IPLs to the PSTN at one
or both ends to provide switched services, commonly known as ISR. A carrier
generally may only offer ISR services to a foreign country if the FCC has found
(a) the country is a member of the WTO and at least 50% of the U.S. billed and
settled traffic to that country is settled at or below the benchmark settlement
rate adopted by the FCC in IB Docket No. 96-261; or (b) the country is not a WTO
member, but it offers U.S. carriers equivalent opportunities to engage in ISR
and at least 50% of the U.S. billed and settled traffic is settled at or below
the applicable benchmark. Settled traffic refers to traffic subject to an
accounting rate agreement between U.S. and foreign carriers. An accounting rate
is a per minute wholesale charge negotiated by international carriers for
terminating traffic in either direction. Each carrier is paid a settlement rate
for terminating traffic on its own network which ordinarily is one-half of the
accounting rate. The Company's FCC authority currently permit it to provide ISR
service to Canada, the U.K., Sweden, New Zealand, Australia and the Netherlands.
The FCC is currently reviewing U.S. carrier applications to provide ISR to
Belgium, Chile, Denmark, Finland, France, Germany, Hong Kong, Norway and
Luxembourg, among other routes, and upon grant of any such ISR application to a
given country, the FCC's rules also would permit the Company to provide ISR
service to that country. Certain of the Company's termination arrangements with
foreign operators involve IPL arrangements which may be inconsistent with the
foregoing FCC IPL resale policy and the Company's existing ISR authorization. If
the FCC were to determine, by its own actions or in response to the filing of a
third party that any of the Company's IPL arrangements violate its ISR policy or
the Company's ISR authorization, the FCC could order the Company to terminate
any non-conforming arrangements. In addition, the Company could be subject to a
monetary forfeiture and to other penalties, including the revocation of the
Company's FCC authorizations to operate as an international carrier. Any such
FCC action could have a material adverse effect upon the Company's business,
operating results and financial condition.
FCC INTERNATIONAL SETTLEMENTS POLICY. The FCC's International Settlement
Policy ("ISP") places limits on the arrangements which U.S. international
carriers may enter into with foreign carriers for exchanging public switched
telecommunications traffic, which the FCC terms International Message Telephone
Service ("IMTS"). The policy does not apply to ISR services. The ISP is
primarily intended to deter dominant foreign carriers from discriminating
amongst competing U.S. carriers by, for example, favoring the foreign carrier's
U.S. affiliate. Absent FCC consent, the ISP requires that U.S. carriers receive
an equal share of the accounting rate (i.e., that settlement rates be
equivalent) and receive inbound traffic in proportion to the volume of U.S.
outbound traffic which they generate. The ISP and other FCC policies also
prohibit a U.S. carrier from offering or accepting a "special concession" from a
foreign carrier where the foreign carrier possess sufficient market power on the
foreign end of the route to affect competition adversely in the U.S. market. A
"special concession" is defined by the FCC as an exclusive arrangement involving
services, facilities or functions on the foreign end of a U.S. international
route which are necessary for providing basic telecommunications which are not
offered to similarly situated U.S. carriers authorized to serve that route. U.S.
international carriers wishing to establish settlement arrangements for IMTS
which do not comply with the ISP must obtain a waiver of the FCC's rules or a
declaratory ruling from the FCC under the FCC's "flexibility" policy that the
non-standard arrangement is in the public interest. FCC policy provides that a
request by a U.S. international carrier to establish a non-standard settlement
arrangement with a foreign carrier in a WTO member country is presumptively in
the public interest, and that said presumption generally may be overcome only by
a demonstration that the foreign carrier is not subject to competition in its
home market from more than one facilities-based international
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carrier. Notwithstanding the FCC's ISP waiver and flexibility policies, it is
possible that the FCC could find that certain of the Company's arrangements with
foreign operators were or are inconsistent with the ISP and that the Company has
not requested prior FCC authority therefore. If the FCC were to determine by its
own actions or in response to the filing of a third party that the Company has
violated the ISP, the FCC could order the Company to terminate any
non-conforming arrangement. In addition, the Company could be subject to a
monetary forfeiture and to other penalties, including revocation of the
Company's FCC authorizations to operate as an international carrier. Any such
FCC action could have a material adverse effect upon the Company's business,
operating results and financial condition.
The FCC's policies also require U.S. international carriers providing IMTS
to negotiate and adopt settlement rates with foreign correspondents for IMTS
which are at or below certain benchmark rates beginning January 1, 1999 for high
income countries. U.S. international carriers must establish IMTS settlement
rates at or below the benchmark rate with any foreign affiliate beginning April
1, 1998. The Company expects that any IMTS operating agreement which it has or
may have with a foreign affiliate will satisfy the foregoing benchmarks
requirement.
The Company currently has IMTS operating agreements with certain foreign
correspondents which provide for settlement rates above the FCC's prescribed
benchmarks. The Company will negotiate in good faith to establish IMTS
settlement rates with its foreign correspondents which satisfy the FCC's
benchmarks but there can be no assurance that such negotiations will succeed.
The FCC's order adopting the foregoing settlement benchmarks and the timetable
therefor is currently being reconsidered by the FCC. Several foreign
telecommunications carriers also have petitioned the U.S. Court of Appeals to
vacate the FCC's benchmarks order arguing that, among other things, the FCC
lacks the jurisdiction to prescribe the settlement rates which foreign carriers
may collect from U.S. carriers. However, subject to FCC reconsideration and
action by the Court of Appeals, if the Company is unable to negotiate benchmark
settlement rates with certain foreign correspondents, the FCC may intervene on
its own action or in response to a filing by a third party. The Company is
unable to predict the form which such intervention may take but it could disrupt
the Company's arrangement for transmitting traffic to certain countries require
the Company to suspend direct service to certain countries or require the
Company to make alternative termination arrangements with certain countries, all
of which could have a material adverse effect on the Company's business,
operating results and financial condition.
FCC POLICIES ON TRANSIT AND REFILE. International switched
telecommunication traffic is frequently routed indirectly via one or more third
countries to its final destination. When such arrangements are mutually agreed,
they are commonly based on a transit agreement under which settlement payments
are made to all parties. In other cases, traffic may be sent to a third country
and then forwarded or refiled for delivery to its final destination without the
knowledge or consent of the destination carrier. The Company uses both transit
and refile arrangements to terminate its international traffic. The FCC
routinely approves transit arrangements by U.S. international carriers. The
FCC's rules also permit carriers to use ISR facilities in many cases to route
traffic via a third country for refile through the public switched network.
However, the extent to which U.S. carriers may enter into refile arrangements
consistent with the ISP is currently under review by the FCC. In 1997, the FCC
stated that above-cost accounting rates had led an increasing amount of
international traffic to migrate to least cost routes through the use of
practices such as hubbing, refile and reorigination. The FCC stated that such
practices are an economically rational response to inflated settlement rates.
Notwithstanding the FCC's past rules, policies and statements regarding the
scope of permissible transit and refile arrangements, the FCC could find by its
own actions or in response to the filing of a third party, that certain of the
Company's transit or refile arrangements violate the ISP or other FCC policies.
In that event, the FCC could order the Company to terminate any non-conforming
transit or refile arrangements. In addition, the Company could be subject to a
monetary forfeiture and to other penalties, including revocation of the
Company's FCC authorizations to operate as an international carrier. Any such
FCC action could have a material adverse effect on the Company's business,
operating results and financial condition.
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REPORTING REQUIREMENTS. International telecommunication carriers also are
required by the FCC's rules timely to file certain reports regarding
international traffic and revenues, the ownership and use of international
facilities and their affiliates with foreign carriers. The FCC considers a U.S.
carrier to be affiliated with a foreign carrier if it has a 25% interest in the
capital stock of the carrier or it controls the foreign carrier or is under
common ownership or control. The FCC requires these reports so that, among other
things, it may monitor the development of industry competition and the potential
for a dominant foreign carrier to discriminate amongst U.S. carriers. The
Company generally has filed said traffic, facilities and foreign affiliation
reports. The FCC's rules require international telecommunication carriers to
file at the FCC copies of their contracts with other carriers, including
operating agreements, within 30 days of execution. The Company has filed copies
of its operating agreements with the FCC. Competitive U.S. international
carriers do not routinely file other carrier-to-carrier contracts with the FCC
and, consistent with industry practice, the Company has not filed certain other
carrier contracts. Notwithstanding the foregoing FCC filings by the Company, the
FCC by its own action or in response to the filing of a third party could
determine that the Company has failed to meet certain of the foregoing filing
and reporting requirements or that certain Company filings are deficient. In
that event, the Company could be directed to remedy any asserted non-compliance;
the Company could also be subject to a monetary forfeiture and to other
penalties, and, although the Company believes that it would be largely
unprecedented in such circumstances, and hence unlikely, the FCC could revoke
the Company's authorizations to operate as an international carrier. Any such
FCC action could have a material adverse affect on the Company's business,
results and financial condition.
REGULATORY FEES. The Communications Act and FCC rules and policies impose
certain fees upon carriers providing interstate and international
telecommunication services. These fees are levied, among other things, to defray
the FCC's operating expenses, to underwrite universal telecommunication service
(e.g., by subsidizing certain services used by schools and libraries, such as
Internet access, and by other telecommunications users in areas of the U.S.
where service costs are significantly above average), to fund the
Telecommunications Relay Service ("TRS"), which provides special options for
hearing-impaired users, and to support the administration of telephone numbering
plans.
Carriers that provide domestic interstate services must pay an annual
regulatory fee based on their interstate revenues; the fee is currently 0.12% of
revenue. The bulk of the Company's revenue, which is derived from international
services, is not subject to this fee. Carriers that provide domestic interstate
services to end users must pay a universal telecommunications service fee each
month based upon the total estimated demand for U.S. universal service funding.
If applicable, each carrier's share is approximately four percent of the
carrier's annual end user revenues. The Company generally offers its services
only to other carriers which in turn provide services to end-users. Such
carrier-to-carrier revenues are not subject to universal service fees, and thus
the Company generally is not liable to pay universal service fees. Carriers that
only offer international service (i.e., service between the United States and a
foreign country or service between two foreign carriers) also are not subject to
the universal service fee. However, if an international carrier has an affiliate
that provides domestic interstate services, then the carrier's international
revenues are subject to said fee. Until its acquisition of LDS, the Company did
not offer domestic interstate services. As a result of the operations of LDS,
any revenue the Company receives from end users for international services may
be subject to universal service fees. U.S. interstate and international carriers
must pay a percentage of their total revenue each year to support the North
American Numbering Plan Administrator. For the 1998 filing year, the
contribution rate is less than .003 percent of net telecommunications revenue.
U.S. carriers must pay a certain percentage of their domestic interstate
revenues to support the TRS Fund. For the 1998 filing year, the contribution
rate is less than .04 percent of gross domestic interstate revenue. The Company
has routinely paid the foregoing regulatory fees and, with regard to the annual
regulatory fees owed by interstate carriers, the Company is currently owed
approximately $20,000 by the FCC due to the inadvertent overpayment of said fee
for a prior year. The foregoing regulatory fees typically change annually. The
Company cannot predict the future regulatory fees for which it may be liable.
Said fees could rise significantly for the Company and amount to four percent or
more of the
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Company's gross international and interstate revenues if the Company is no
longer exempt from paying universal service fees as a result of an affiliate's
provision of domestic interstate services, or because the Company provides
service directly to end users, or because amendments to the Communications Act
repeal the universal service fee exemption for carriers which only offer
international service or services provided to connecting carriers. Because the
international telecommunication services business is highly competitive, an
increase in the regulatory fees which the Company must pay could impair its
market position and have a material adverse effect on the Company's business,
operating results and financial condition.
RECENT AND POTENTIAL FCC ACTIONS. Recent FCC rulemaking orders and other
actions have lowered the entry barriers for new facilities-based and resale
international carriers by streamlining the processing of new applications and
granting non-dominant carriers greater flexibility in establishing non-standard
settlement arrangements with non-dominant foreign carriers, including the
non-dominant U.S. affiliates of such carriers. In addition, the FCC's rules
implementing the WTO Agreement presume that competition will be advanced by the
U.S. entry of facilities-based and resale carriers from WTO member countries,
thus further increasing the number of potential competitors in the U.S. market
and the number of carriers which may also offer end-to-end services. The FCC is
reviewing the proposed merger of WorldCom and MCI, and is expected soon to
review the proposed merger of LCI International, Inc. and Qwest Communications
International Inc. FCC approval and consummation of these mergers would increase
concentration in the international telecommunications service industry and the
potential market power of the Company's competitors. The FCC also recently has
sought to reduce the foreign termination costs of U.S. international carriers by
prescribing maximum or benchmark settlement rates which foreign carriers may
charge U.S. carriers for terminating switched telecommunications traffic and, if
the FCC's benchmarks order survives judicial review, the FCC's action may reduce
the Company's settlement costs, although the costs of other U.S. international
carriers also may be reduced in a similar fashion. The FCC has not stated how it
will enforce the new settlement benchmarks if U.S. carriers are unsuccessful in
negotiating settlement rates at or below the prescribed benchmarks, but any
future FCC intervention could disrupt the Company's transmission arrangements to
certain countries or require the Company to modify its existing arrangements;
other U.S. international carriers might be similarly affected. The 1996
amendment to the Communications Act permits the FCC to forbear enforcement of
the tariff provisions in the Act, which apply to all interstate and
international carriers, and the U.S. Court of Appeals is currently reviewing an
FCC order directing all domestic interstate carriers to detariff their
offerings. Subject to the Court's decision, the FCC may forbear its current
tariff rules for U.S. international carriers, such as the Company, or order such
carriers to detariff their services. In that event, the Company would have
greater flexibility in pricing its service offerings and to compete, although
any such FCC action likely would grant other non-dominant international carriers
equivalent freedom. The FCC routinely reviews the contribution rate for various
levels of regulatory fees, including the rate for fees levied to support
universal service, which fees may be increased in the future for various
reasons, including the need to support the universal service programs mandated
by the Communications Act, the total costs for which are still under review by
the FCC. The FCC also is reviewing the extent to which international carriers
may refile traffic using international private line facilities or otherwise.
Future FCC actions regarding refile could affect the Company by, for example,
requiring it to discontinue certain termination arrangements which it now has or
to implement alternative routing arrangements for certain countries; on the
other hand, the FCC may further liberalize its existing rules and policies
regarding refile in which case the Company is likely to be well positioned to
expand certain refile operations even though new opportunities may become
available to its competitors. The Company can not predict the net effect of
these or other possible future FCC actions on its business, operating results
and financial condition, although the net effect could be material.
STATE REGULATION
STATE. The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or
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tariff requirements. In certain states, prior regulatory approval is required
for changes in control of telecommunications services. The vast majority of
states require STAR and its subsidiaries to apply for certification to provide
intrastate telecommunications services, or at a minimum to register or to be
found to be exempt from regulation, prior to commencing sale of intrastate
services. Additionally, the vast majority of states require STAR or its
subsidiaries to file and maintain detailed tariffs setting forth rates charged
by STAR to its end-users for intrastate services. Many states also impose
various reporting requirements and/or require prior approval for transfers of
control of certificated carriers and assignments of carrier assets, including
customer bases, carrier stock offerings, and incurrence by carriers of
significant debt. Certificates of authority can generally be conditioned,
modified, canceled, terminated or revoked by state regulatory authorities for
failure to comply with state laws and/or rules, regulations and policies of the
state regulatory authorities. Fines and other penalties, including, for example,
the return of all monies received for intrastate traffic from residents of a
state in which a violation has occurred may be imposed.
STAR, along with its regulated subsidiaries, believes it has made the
filings and taken the actions it believes are necessary to provide the
intrastate services it currently provides to end users throughout the U.S. STAR
and/or its subsidiaries are qualified to do business as foreign corporations,
and have received certification to provide intrastate telecommunications
services in all states where certification is required, and have received
approval for changes of control where such approvals are necessary. The Company
and its subsidiaries are required to make periodic filings in order to maintain
certificated status and remain qualified as foreign corporations.
In early 1997, the FCC instituted significant changes to the current
incumbent local exchange carrier access charge structure. These changes were
meant, in part, to bring access charges closer to their actual costs. While
there has been a general trend towards access charge reductions, new primary
interexchange carrier charges (PICCs) were authorized by the FCC to be imposed
on interexchange carriers serving presubscribed access charges closer to their
actual costs. PICCs are a flat-rated, per presubscribed line, per month access
charge imposed upon all facilities-based carriers (although they may be passed
through to resellers). Facilities-based carriers were assessed interstate PICCs
effective January 1, 1998. Intrastate PICCs have also been adopted in the five
state Ameritech region (Michigan, Wisconsin, Illinois, Indiana, and Ohio), and
may be adopted elsewhere. At the same time, the Company may pursue underlying
carriers for pass throughs of any access charge reductions they may realize from
incumbent local exchange carriers.
ACTIONS AGAINST LDS. In 1997, prior to the Company's acquisition of LDS,
LDS settled disputes with the California Public Utilities Commission (the
"California PUC") and with the District Attorney of Monterey, California
regarding LDS' alleged unauthorized switching of long distance customers (the
"Settlements"). As part of the Settlements, LDS was subject to fines and
restrictions on its business operations in California. In addition, the FCC has
received numerous informal complaints against LDS regarding the alleged
unauthorized switching of long distance customers, which complaints currently
remain under review.
Following the Company's acquisition of LDS and in order to comply with the
Settlements, STAR has imposed strict restrictions on certain former LDS
employees, restricting these employees with respect to California intrastate
telecommunications operations. Additionally, the Company has taken a number of
steps to reduce the risk of a repeat occurrence regarding the alleged
unauthorized switching of commercial customers in California. There can,
however, be no assurance that LDS or STAR will not be subject to further
regulatory review by the California PUC or the FCC.
FOREIGN REGULATION
UNITED KINGDOM. In the U.K., telecommunications services offered by the
Company and through its affiliate, STAR Europe Ltd., ("STAR Europe") are subject
to regulation by various U.K. regulatory agencies. The U.K. generally permits
competition in all sectors of the telecommunications market, subject to
licensing requirements and license conditions. The Company has been granted a
license to provide
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international services on a resale basis and STAR Europe has been granted a
license to provide international services over its own facilities, which
licenses are subject to a number of restrictions. Implementation of these
licenses have permitted the Company to engage in cost-effective routing of
traffic between the U.S. and the U.K. and beyond.
GERMANY. In Germany, telecommunications services offered by the Company
through its affiliate, STAR Telecommunications Deutschland GmbH ("STAR
Germany"), are subject to regulation by the Regulierungsbehorde fur
Telekommunikation und Post (which is under the jurisdiction of the Ministry of
Economy). Germany permits the competitive provision of international
facilities-based and resale services. STAR Germany was granted a license for the
provision of voice telephony on the basis of self-operated telecommunications
networks on December 4, 1997. Under this license, STAR Germany is presently
installing telecommunications switching facilities in Dusseldorf, Frankfurt,
Hamburg and Munich and is leasing connection transmission facilities between
these switches and additional facilities. The network of STAR Germany will be
used primarily for routing international telecommunications traffic between the
U.S., the U.K., Germany and beyond. There can be no assurance that future
changes in regulation of the services provided by STAR Germany will not have a
material adverse effect on the Company's business, operating results and
financial condition.
OTHER COUNTRIES. The Company plans to initiate a variety of services in
certain European countries including France and Belgium. These services will
include value-added services to closed user groups and other voice services as
regulatory liberalization in those countries permits. These and other countries
have announced plans or adopted laws to permit varying levels of competition in
the telecommunications market. Under the terms of the WTO Agreement, each of the
signatories has committed to opening its telecommunications market to
competition, foreign ownership and to adopt measures to protect against
anticompetitive behavior, effective starting on January 1, 1998. Although the
Company plans to obtain authority to provide service under current and future
laws of those countries, or, where permitted, provide service without government
authorization, there can be no assurance that foreign laws will be adopted and
implemented providing the Company with effective practical opportunities to
compete in these countries. Moreover, there can be no assurance of the nature
and pace of liberalization in any of these markets. The Company's inability to
take advantage of such liberalization could have a material adverse affect on
the Company's ability to expand its services as planned.
EMPLOYEES
As of March 1, 1998, the Company employed 454 full-time employees. The
Company is not subject to any collective bargaining agreement and it believes
that its relationships with its employees are good.
RISK FACTORS
IN EVALUATING THE COMPANY, ITS BUSINESS, OPERATIONS AND FINANCIAL POSITION,
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY, IN ADDITION TO THE
OTHER INFORMATION CONTAINED IN THIS FORM 10-K. THE FOLLOWING FACTORS, AMONG
OTHERS, COULD AFFECT THE COMPANY'S ACTUAL FUTURE OPERATING RESULTS AND COULD
CAUSE SUCH RESULTS TO DIFFER FROM THE RESULTS DISCUSSED IN ANY FORWARD-LOOKING
STATEMENTS MADE BY OR ON BEHALF OF THE COMPANY.
OPERATING RESULTS SUBJECT TO SIGNIFICANT FLUCTUATIONS
The Company's quarterly operating results are difficult to forecast with any
degree of accuracy because a number of factors subject these results to
significant fluctuations. As a result, the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as indications of future performance.
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FACTORS INFLUENCING OPERATING RESULTS, INCLUDING REVENUES, COSTS AND
MARGINS. The Company's revenues, costs and expenses have fluctuated
significantly in the past and are likely to continue to fluctuate significantly
in the future as a result of numerous factors. The Company's revenues in any
given period can vary due to factors such as call volume fluctuations,
particularly in regions with relatively high per-minute rates; the addition or
loss of major customers, whether through competition, merger, consolidation or
otherwise; the loss of economically beneficial routing options for the
termination of the Company's traffic; financial difficulties of major customers;
pricing pressure resulting from increased competition; and technical
difficulties with or failures of portions of the Company's network that impact
the Company's ability to provide service to or bill its customers. The Company's
cost of services and operating expenses in any given period can vary due to
factors such as fluctuations in rates charged by carriers to terminate the
Company's traffic; increases in bad debt expense and reserves; the timing of
capital expenditures, and other costs associated with acquiring or obtaining
other rights to switching and other transmission facilities; changes in the
Company's sales incentive plans; and costs associated with changes in staffing
levels of sales, marketing, technical support and administrative personnel. In
addition, the Company's operating results can vary due to factors such as
changes in routing due to variations in the quality of vendor transmission
capability; loss of favorable routing options; the amount of, and the accounting
policy for, return traffic under operating agreements; actions by domestic or
foreign regulatory entities; the level, timing and pace of the Company's
expansion in international and commercial markets; and general domestic and
international economic and political conditions. Further, a substantial portion
of transmission capacity used by the Company is obtained on a variable, per
minute and short term basis, subjecting the Company to the possibility of
unanticipated price increases and service cancellations. Since the Company does
not generally have long term arrangements for the purchase or resale of long
distance services, and since rates fluctuate significantly over short periods of
time, the Company's gross margins are subject to significant fluctuations over
short periods of time. The Company's gross margins also may be negatively
impacted in the longer term by competitive pricing pressures.
EXAMPLES OF FACTORS AFFECTING OPERATING RESULTS. The Company has in the
past encountered significant difficulties in the collection of accounts
receivable from certain of its customers. For example, in the fourth quarter of
1996 and the first quarter of 1997, Hi-Rim Communications, Inc. ("Hi-Rim"),
formerly one of the Company's major customers and Cherry Communications, Inc.
("CCI"), the Company's largest customer in 1996 experienced financial
difficulties and were unable to pay in full, on a timely basis, outstanding
accounts receivable. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations." In early 1997, the Company implemented
more stringent credit policies and monitoring systems. There can be no
assurance, however, that if the Company experiences similar difficulties in the
collection of future accounts receivable from its customers, the Company's
financial condition and results of operations would not be materially adversely
affected.
ABILITY TO CONTINUE AND MANAGE GROWTH; COMMERCIAL MARKET
The Company has increased revenues from $46.3 million in 1995 to $376.2
million in 1997, with revenues increasing in each of the last ten quarters. Such
growth should not be considered indicative of future revenue growth or operating
results. If revenue levels fall below expectations, net income is likely to be
disproportionately adversely affected because a proportionately smaller amount
of the Company's operating expenses varies with its revenues. This effect is
likely to increase as a greater percentage of the Company's cost of services are
associated with owned and leased facilities. There can be no assurance that the
Company will be able to achieve or maintain profitability on a quarterly or
annual basis in the future. It is likely that in some future quarter the
Company's operating results will be below the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
would likely be materially adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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As part of the Company's significant revenue growth, it has expanded, and
plans to continue to expand, the number of its employees and the geographic
scope of its operations. Additionally, an important component of the Company's
strategy is to grow and expand through acquisition. These factors have resulted,
and will continue to result, in increased responsibilities for management
personnel and have placed, and will continue to place, increased demands upon
the Company's operating and financial systems, which may lead to unanticipated
costs and divert management's attention from day-to-day operations. The Company
may also be required to attract, train and retain additional highly qualified
management, technical, sales and marketing and customer support personnel. The
process of locating such personnel with the combination of skills and attributes
required to implement the Company's strategy is often lengthy. The inability to
attract and retain additional qualified personnel could materially and adversely
affect the Company. The Company expects that its expansion into foreign
countries will lead to increased financial and administrative demands, such as
increased operational complexity associated with expanded network facilities,
administrative burdens associated with managing an increasing number of foreign
subsidiaries and relationships with foreign partners and expanded treasury
functions to manage foreign currency risks. The Company's accounting systems and
policies have been developed as the Company has experienced significant growth.
There can be no assurance that the Company's personnel, systems, procedures and
controls will be adequate to support the Company's future operations.
See "--Dependence on Key Personnel," "Business--Employees" and "Directors and
Executive Officers of the Registrant."
With the acquisition of LDS, STAR began providing service to the commercial
market, which is more labor intensive than the wholesale market, and as a result
has higher overhead costs. The Company also may be required to update and
improve its billing systems and procedures and/or hire new management personnel
to handle the demands of the commercial market. There can be no assurance that
the Company will be able to effectively manage the costs of and risks associated
with its expansion into the commercial market.
RISKS INHERENT IN ACQUISITION STRATEGY
An important component to the Company's strategy is to grow and expand
through acquisitions. This growth strategy is dependent on the continued
availability of suitable acquisition candidates and subjects the Company to a
number of risks. The Company has recently completed two acquisitions, LDS on
November 30, 1997, and T-One on March 10, 1998. Additionally, on November 19,
1997, the Company entered into an agreement to acquire UDN. The acquisition of
UDN is subject to approval of UDN's stockholders and to various regulatory
approvals, and the Company may not complete this acquisition. These acquisitions
have placed significant demands on the Company's financial and management
resources, as the process for integrating acquired operations presents a
significant challenge to the Company's management and may lead to unanticipated
costs or a diversion of management's attention from day-to-day operations. There
can be no assurance that the Company will be able to successfully integrate
these acquisitions or any other acquisitions made by the Company in the future
into Company operations. Integrating acquisitions may require integration of
financial and call routing systems, network and other physical facilities and
personnel. Difficulties in integrating these and other acquisitions can cause
system degradation, added costs and loss of personnel or customers.
Additionally, the Company may incur unknown liabilities despite management's
efforts to investigate the operations of the acquired business. The impact of
these risks, and other risks arising as a result of STAR's acquisition strategy,
could adversely affect the Company's operating results.
RISKS ASSOCIATED WITH GROWTH OF TELECOMMUNICATIONS NETWORK AND CUSTOMER BASE
Historically, the Company has relied primarily on leased transmission
capacity for the delivery of its telecommunications services. The Company's
telecommunications expenses have in the past primarily been variable, based upon
minutes of use, consisting largely of payments to other long distance carriers,
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<PAGE>
customer/carrier interconnect charges, leased fiber circuit charges and switch
facility costs. During 1997, however, the Company made considerable capital
expenditures in order to expand its network, and intends to continue to do so in
the future. See "Business--Network." Although the Company's strategy is to seek
to establish significant traffic volumes prior to investing in fixed-cost
facilities, the development of such facilities entails significant costs and
prior planning, which are based in part on the Company's expectations concerning
future revenue growth and market developments. As the Company expands its
network and the volume of its network traffic, its cost of revenues will
increasingly consist of fixed costs arising from the ownership and maintenance
of its switches and undersea fiber optic cables. While the Company believes that
in the long-term these investments will allow it to reduce its cost of service
and to enhance its service offerings, in the short-term, costs increases and a
decrease in the Company's operating margins may occur. If the Company's traffic
volume were to decrease, or fail to increase to the extent expected or necessary
to make efficient use of its network, the Company's costs as a percentage of
revenues could increase significantly, which could have a material adverse
effect on the Company's business, financial condition or results of operations.
In addition, the Company's business depends in part on its ability to obtain
transmission facilities on a cost-effective basis. Because undersea fiber optic
cables typically take several years to plan and construct, carriers generally
make investments well in advance, based on a forecast of anticipated traffic.
Therefore, the Company's operations are subject to the risk that it will not
adequately anticipate the amount of traffic over its network, and may not
procure sufficient cable capacity or network equipment in order to ensure the
cost-effective transmission of customer traffic. Although the Company
participates in the planning of undersea fiber optic transmission facilities, it
does not control the construction of such facilities and must seek access to
such facilities through partial ownership positions. If ownership positions are
not available, the Company must seek access to such facilities through lease
arrangements on negotiated terms that may vary with industry and market
conditions. There can be no assurance that the Company will be able to continue
to obtain sufficient transmission facilities or access to undersea fiber optic
cable on economically viable terms. The failure of the Company to obtain
telecommunications facilities that are sufficient to support its network traffic
in a manner that ensures the reliability and quality of its telecommunications
services may have a material adverse effect on its business, financial condition
or results of operations.
RISKS OF INTERNATIONAL TELECOMMUNICATIONS BUSINESS
The Company has to date generated a substantial majority of its revenues by
providing international telecommunications services to its customers on a
wholesale basis. The international nature of the Company's operations involves
certain risks, such as changes in U.S. and foreign government regulations and
telecommunications standards, dependence on foreign partners, tariffs, taxes and
other trade barriers, the potential for nationalization and economic downturns
and political instability in foreign countries. In addition, the Company's
business could be adversely affected by a reversal in the current trend toward
deregulation of telecommunications carriers. The Company will be increasingly
subject to these risks to the extent that the Company proceeds with the planned
expansion of its international operations.
RISK OF DEPENDENCE ON FOREIGN PARTNERS. The Company will increasingly rely
on foreign partners to terminate its traffic in foreign countries and to assist
in installing transmission facilities and network switches, complying with local
regulations, obtaining required licenses, and assisting with customer and vendor
relationships. The Company may have limited recourse if its foreign partners do
not perform under their contractual arrangements with the Company. The Company's
arrangements with foreign partners may expose the Company to significant legal,
regulatory or economic risks.
RISKS ASSOCIATED WITH FOREIGN GOVERNMENT CONTROL AND HIGHLY REGULATED
MARKETS. Governments of many countries exercise substantial influence over
various aspects of the telecommunications market. In some cases, the government
owns or controls companies that are or may become competitors of the Company or
companies (such as national telephone companies) upon which the Company and its
foreign partners may depend for required interconnections to local telephone
networks and other services.
20
<PAGE>
Accordingly, government actions in the future could have a material adverse
effect on the Company's operations. In highly regulated countries in which the
Company is not dealing directly with the dominant local exchange carrier, the
dominant carrier may have the ability to terminate service to the Company or its
foreign partner and, if this occurs, the Company may have limited or no
recourse. In countries where competition is not yet fully established and the
Company is dealing with an alternative operator, foreign laws may prohibit or
impede new operators from offering services in these markets.
RISKS ASSOCIATED WITH FOREIGN CURRENCY FLUCTUATIONS. The Company's revenues
and cost of long distance services are sensitive to foreign currency
fluctuations. The Company expects that an increasing portion of the Company's
net revenue and expenses will be denominated in currencies other than U.S.
dollars, and changes in exchange rates may have a significant effect on the
Company's results of operations. Although the Company utilizes hedging
instruments to reduce the risk of foreign currency fluctuations, the Company
will not be fully protected from these risks and the instruments themselves
involve a degree of risk. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
FOREIGN CORRUPT PRACTICES ACT. The Company is also subject to the Foreign
Corrupt Practices Act ("FCPA"), which generally prohibits U.S. companies and
their intermediaries from bribing foreign officials for the purpose of obtaining
or keeping business. The Company may be exposed to liability under the FCPA as a
result of past or future actions taken without the Company's knowledge by
agents, strategic partners and other intermediaries. Such liability could have a
material adverse effect on the Company's business, operating results and
financial condition.
POTENTIAL ADVERSE EFFECTS OF GOVERNMENT REGULATION
The Company's business is subject to various U.S. and foreign laws,
regulations, agency actions and court decisions. The Company's U.S.
international telecommunications service offerings are subject to regulation by
the FCC. The FCC requires international carriers to obtain authorizations under
Section 214 of the Communications Act prior to acquiring international
facilities by purchase or lease, or providing international service to the
public. Prior FCC approval is also required to transfer control of a
certificated carrier. The Company must file reports and contracts with the FCC
and must pay regulatory fees, which are subject to change. The Company is also
subject to the FCC policies and rules discussed below. The FCC could determine,
by its own actions or in response to a third party's filing, that certain of the
Company's services, termination arrangements, agreements with foreign carriers,
transit or refile arrangements or reports do not or did not comply with FCC
policies and rules. If this occurred, the FCC could order the Company to
terminate noncompliant arrangements, fine the Company or revoke the Company's
authorizations. Any of these actions could have a material adverse effect on the
Company's business, operating results and financial condition.
FCC INTERNATIONAL PRIVATE LINE RESALE POLICY. The FCC's IPL resale policy
limits the conditions under which a carrier may connect IPLs to the PSTN at one
or both ends to provide switched services, commonly known as ISR. A carrier
generally may only offer ISR services to a foreign country if the FCC has found
(a) the country is a member of the WTO and at least 50% of the U.S. billed and
settled traffic to that country is settled at or below the FCC's benchmark
settlement rate or (b) the country is not a WTO member, but it offers U.S.
carriers equivalent opportunities to engage in ISR and at least 50% of the U.S.
billed and settled traffic is settled at or below the applicable benchmark. The
Company's FCC authority currently permits it to provide ISR service to Canada,
the U.K., Sweden, New Zealand, Australia and the Netherlands. The FCC is
currently reviewing U.S. carrier applications to provide ISR to Belgium, Chile,
Denmark, Finland, France, Germany, Hong Kong, Norway and Luxembourg, among other
routes. Upon grant of any such ISR application to a given country, the FCC's
rules also would permit the Company to provide ISR service to that country.
Certain of the Company's termination arrangements with foreign
21
<PAGE>
operators may be inconsistent with the FCC's IPL resale policy and the Company's
existing ISR authorization.
FCC INTERNATIONAL SETTLEMENTS POLICY. The FCC's ISP limits the arrangements
which U.S. international carriers may enter into with foreign carriers for
exchanging public switched telecommunications traffic, which the FCC terms
International Message Telephone Service. This policy does not apply to ISR
services. The ISP requires that U.S. carriers receive an equal share of the
accounting rate and receive inbound traffic in proportion to the volume of U.S.
outbound traffic which they generate. The ISP and other FCC policies also
prohibit a U.S. carrier and a foreign carrier which possesses sufficient market
power on the foreign end of the route to affect competition adversely in the
U.S. market from entering into exclusive arrangement involving services,
facilities or functions on the foreign end of a U.S. international route which
are necessary for providing basic telecommunications and which are not offered
to similarly situated U.S. carriers. It is possible that the FCC could find that
certain of the Company's arrangements with foreign operators are inconsistent
with the ISP.
FCC POLICIES ON TRANSIT AND REFILE. The Company uses both transit and
refile arrangements to terminate its international traffic. The FCC routinely
approves transit arrangements by U.S. international carriers. The FCC's rules
also permit carriers in many cases to use ISR facilities to route traffic via a
third country for refile through the PSTN. The extent to which U.S. carriers may
enter into refile arrangements consistent with the ISP is currently under review
by the FCC. Certain of the Company's transit or refile arrangements may violate
the ISP or other FCC policies.
RECENT AND POTENTIAL FCC ACTIONS. Regulatory action that may be taken in
the future by the FCC may intensify the competition which the Company faces,
impose additional operating costs upon the Company, disrupt certain of the
Company's transmission arrangements or otherwise require the Company to modify
its operations. Future FCC action may also provide the Company additional
competitive flexibility by, for example, eliminating or substantially reducing
the tariff requirements applicable to the Company's interstate and international
telecommunications services. The FCC is encouraging new market entrants by
implementing the WTO Agreement and through other actions. The FCC may approve
pending mergers which could produce more effective competitors in the Company's
markets. The FCC may increase regulatory fees charged to the Company and its
competitors by eliminating the exemption for carriers which provide only
international services or through other actions, which could raise the Company's
costs of service without assurance that the Company and its competitors could
pass fee increases through to their customers. See "Business--Government
Regulation."
STATE. The intrastate long distance telecommunications operations of STAR
and its subsidiaries are subject to various state laws and regulations,
including prior certification, notification, registration and/or tariff
requirements. The vast majority of states require that STAR and its subsidiaries
apply for certification to provide intrastate telecommunications services.
Certificates of authority can generally be conditioned, modified or revoked by
state regulatory authorities for failure to comply with state laws and
regulations. Fines and other penalties, including revocation of a certificate of
authority, may be imposed.
In 1997, prior to the Company's acquisition of LDS, LDS settled disputes
with the California PUC and with the District Attorney of Monterey, California
regarding LDS' alleged unauthorized switching of long distance customers. As
part of the Settlements, LDS was subject to fines and restrictions on its
business operations in California. In addition, the FCC has received numerous
informal complaints against LDS regarding the alleged unauthorized switching of
long distance customers, which complaints currently remain under review.
Following the Company's acquisition of LDS and in order to comply with the
Settlements, STAR has imposed strict restrictions on certain former LDS
employees, restricting these employees with respect to California intrastate
telecommunications operations. Additionally, the Company has taken a number of
steps to reduce the risk of a repeat occurrence regarding the alleged
unauthorized switching of commercial
22
<PAGE>
customers in California. If the Company inadvertently fails to comply with such
guidelines or if such guidelines are determined to be inadequate to comply with
the Settlements, the Company may be subject to penalties or revocation of its
certificate of authority. See "Business--Government Regulation--Actions Against
LDS."
FOREIGN REGULATIONS. The Company is also subject to regulation in foreign
countries, such as the U.K. and Germany, in connection with certain of its
business activities. For example, the Company's use of transit, ISR or other
routing arrangements may be affected by laws or regulations in either the
transited or terminating foreign jurisdiction. Foreign countries, either
independently or jointly as members of the International Telecommunications
Union ("ITU"), or other supra-national organizations such as the European Union
or the WTO, may have adopted or may adopt laws or regulatory requirements
regarding such services for which compliance would be difficult or expensive,
that could force the Company to choose less cost-effective routing alternatives
and that could adversely affect the Company's business, operating results and
financial condition.
To the extent that it seeks to provide telecommunications services in other
non-U.S. markets, the Company is subject to the developing laws and regulations
governing the competitive provision of telecommunications services in those
markets. The Company currently plans to provide a limited range of services in
Mexico, Belgium and France, as permitted by regulatory conditions in those
markets, and to expand its operations as these markets implement scheduled
liberalization to permit competition in the full range of telecommunications
services in the next several years. The nature, extent and timing of the
opportunity for the Company to compete in these markets will be determined, in
part, by the actions taken by the governments in these countries to implement
competition and the response of incumbent carriers to these efforts. There can
be no assurance that the regulatory regime in these countries will provide the
Company with practical opportunities to compete in the near future, or at all,
or that the Company will be able to take advantage of any such liberalization in
a timely manner. See "Business--Government Regulation."
REGULATION OF CUSTOMERS. The Company's customers are also subject to
actions taken by domestic or foreign regulatory authorities that may affect the
ability of customers to deliver traffic to the Company. Regulatory sanctions
have been imposed on certain of the Company's customers in the past. While such
sanctions have not adversely impacted the volume of traffic received by the
Company from such customers to date, future regulatory actions could materially
adversely affect the volume of traffic received from a major customer, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
RISKS OF NETWORK FAILURE
Any system or network failure that causes interruptions in the Company's
operations could have a material adverse effect on its business, financial
condition or results of operations. The Company's operations are dependent on
its ability to successfully expand its network and integrate new and emerging
technologies and equipment into its network, which are likely to increase the
risk of system failure and to cause strain upon the network. The Company's
operations also are dependent on the Company's protection of its hardware and
other equipment from damage from natural disasters such as fires, floods,
hurricanes and earthquakes, other catastrophic events such as civil unrest,
terrorism and war and other sources of power loss and telecommunications
failures. Although the Company has taken a number of steps to prevent its
network from being affected by natural disasters, fire and the like, such as
building redundant systems for power supply to the switching equipment, there
can be no assurance that any such systems will prevent the Company's switches
from becoming disabled in the event of an earthquake, power outage or otherwise.
The failure of the Company's network, or a significant decrease in telephone
traffic resulting from effects of a natural or man-made disaster, could have a
material adverse effect on the Company's relationship with its customers and the
Company's business, operating results and financial condition. See
"Business--Network."
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DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a significant degree upon the efforts of
senior management personnel and a group of employees with longstanding industry
relationships and technical knowledge of the Company's operations, in
particular, Christopher E. Edgecomb, the Company's Chief Executive Officer. The
Company maintains and is the beneficiary under a key person life insurance
policy in the amount of $10.0 million with respect to Mr. Edgecomb. The Company
believes that its future success will depend in large part upon its continuing
ability to attract and retain highly skilled personnel. Competition for
qualified, high-level telecommunications personnel is intense and there can be
no assurance that the Company will be successful in attracting and retaining
such personnel. The loss of the services of one or more of the Company's key
individuals, or the failure to attract and retain other key personnel, could
materially adversely affect the Company's business, operating results and
financial condition. See "Directors and Executive Officers of the Registrant."
SIGNIFICANT COMPETITION
The international telecommunications industry is intensely competitive and
subject to rapid change. The Company's competitors in the international
wholesale switched long distance market include large, facilities-based
multinational corporations and smaller facilities-based providers in the U.S.
and overseas that have emerged as a result of deregulation, switch-based
resellers of international long distance services and international joint
ventures and alliances among such companies. The Company also competes abroad
with a number of dominant telecommunications operators that previously held
various monopolies established by law over the telecommunications traffic in
their countries. International wholesale switched service providers compete on
the basis of price, customer service, transmission quality, breadth of service
offerings and value-added services. Additionally, the telecommunications
industry is in a period of rapid technological evolution, marked by the
introduction of competitive product and service offerings, such as the
utilization of the Internet for international voice and data communications. The
Company is unable to predict which technological development will challenge its
competitive position or the amount of expenditures that will be required to
respond to a rapidly changing technological environment. Further, the number of
the Company's competitors is likely to increase as a result of the competitive
opportunities created by a new Basic Telecommunications Agreement concluded by
members of the WTO in April 1997. Under the terms of the WTO Agreement, starting
February 5, 1998, the United States and over 65 countries have committed to open
their telecommunications markets to competition, foreign ownership and adopt
measures to protect against anticompetitive behavior. As a result, the Company
believes that competition will continue to increase, placing downward pressure
on prices. Such pressure could adversely affect the Company's gross margins if
the Company is not able to reduce its costs commensurate with such price
reductions.
COMPETITION FROM DOMESTIC AND INTERNATIONAL COMPANIES. A majority of the
U.S.-based international telecommunications services revenue is currently
generated by AT&T, MCI and Sprint. The Company also competes with WorldCom,
Pacific Gateway Exchange, Inc. and other U.S.-based and foreign long distance
providers, including the RBOCs, which presently have FCC authority to resell and
terminate international telecommunication services. Many of these competitors
have considerably greater financial and other resources and more extensive
domestic and international communications networks than the Company. The
Company's business would be materially adversely affected to the extent that a
significant number of such customers limit or cease doing business with the
Company for competitive or other reasons. Consolidation in the
telecommunications industry could not only create even larger competitors with
greater financial and other resources, but could also adversely affect the
Company by reducing the number of potential customers for the Company's
services.
EXPANSION INTO COMMERCIAL MARKET. With the acquisition of LDS, STAR began
providing long distance service to the commercial market, a market that is
subject to intense competition from a number of well capitalized companies. The
commercial market is also characterized by the lack of customer loyalty,
24
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with commercial customers regularly changing service providers. There can be no
assurance that STAR will be able to compete successfully in the commercial
market. See "Business--Strategy--Expansion into Commercial Market."
CUSTOMER CONCENTRATION
While the list of the Company's most significant customers varies from
quarter to quarter, the Company's five largest customers accounted for
approximately 30% of its revenues in 1997. The Company could lose a significant
customer for many reasons, including the entrance into the market of significant
new competitors with lower rates than the Company, downward pressure on the
overall costs of transmitting international calls, transmission quality
problems, changes in U.S. or foreign regulations or unexpected increases in the
Company's cost structure as a result of expenses related to installing a global
network or otherwise.
NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS
The Company believes that it must continue to enhance and expand its network
and build out its telecommunications network infrastructure in order to maintain
its competitive position and continue to meet the increasing demands for service
quality, capacity and competitive pricing. The Company's ability to grow
depends, in part, on its ability to expand its operations through the ownership
and leasing of network capacity, which requires significant capital
expenditures, that are often incurred prior to the Company's receipt of the
related revenue.
The Company believes that, based upon its present business plan, the
proceeds from the Offering, as defined, together with the Company's existing
cash resources and expected cash flow from operating activities, will be
sufficient to meet its currently anticipated working capital and capital
expenditure requirements for at least twelve months. If the Company's growth
exceeds current expectations, if the Company obtains one or more attractive
opportunities to purchase the business or assets of another company, or if the
Company's cash flow from operations after the end of such period is insufficient
to meet its working capital and capital expenditure requirements, the Company
will need to raise additional capital from equity or debt sources. There can be
no assurance that the Company will be able to raise such capital on favorable
terms or at all. If the Company is unable to obtain such additional capital, the
Company may be required to reduce the scope of its anticipated expansion, which
could have a material adverse effect on the Company's business, financial
condition or results of operations.
VOLATILITY OF STOCK PRICE
The market price of the shares of Common Stock has risen since the Company's
initial public offering in June 1997 and is trading at a high multiple of the
Company's earnings. The market price for such shares has been highly volatile
and may be significantly affected by factors such as actual or anticipated
fluctuations in the Company's operating results, the announcement of potential
acquisitions by the Company, changes in federal and international regulations,
activities of the largest domestic providers, industry consolidation and
mergers, conditions and trends in the international telecommunications market,
adoption of new accounting standards affecting the telecommunications industry,
changes in recommendations and estimates by securities analysts, general market
conditions and other factors. In addition, the stock market has from time to
time experienced significant price and volume fluctuations that have
particularly affected the market prices for the shares of emerging growth
companies like the Company. These broad market fluctuations may adversely affect
the market price of the Company's Common Stock.
YEAR 2000 COMPUTER PROGRAM FAILURE
A significant percentage of the software that runs most of the computers in
the United States relies on two-digit date codes to perform computations and
decision-making functions. Commencing on January 1,
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2000, these computer programs may fail from an inability to interpret date codes
properly, misinterpreting "00" as the year 1900 rather than 2000. The Company
believes that the Company's billing, credit and call tracking systems are Year
2000 compliant and do not use programs with the two-digit date code flaw. At the
same time, a number of the computers of the Company's customers and vendors that
interface with the Company's systems may run on programs that have Year 2000
problems and may disrupt the Company's billing, credit and tracking systems.
Failure of any of the computer programs integral to the Company's key customers
and vendors could adversely affect the Company's business, operating results and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-K, including without
limitation, statements containing the words "believes," "anticipates,"
"intends," "expects" and words of similar import, constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of the Company to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Such factors include, among others, the
following: general economic and business conditions, both nationally and in the
regions in which the Company operates; industry capacity; existing government
regulations and changes in, or the failure to comply with, government
regulations; competition; changes in business strategy or development plans; the
ability of the Company to manage growth; the availability and terms of capital
to fund the expansion of the Company's business, including the acquisition of
additional businesses; and other factors referenced in this Form 10-K. GIVEN
THESE UNCERTAINTIES, THE STOCKHOLDERS OF THE COMPANY ARE CAUTIONED NOT TO PLACE
UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock has been traded on the Nasdaq National Market
since June 12, 1997. The following table sets forth, for the fiscal periods
indicated, the quarterly high and low sales prices for the Common Stock, as
reported by Nasdaq and as adjusted to reflect the Stock Split that occurred on
March 31, 1998.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
FISCAL YEAR ENDED DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------------
Second Quarter (from June 12, 1997)............................................................ 7 3/8 4 41/64
Third Quarter.................................................................................. 11 53/64 6 7/32
Fourth Quarter................................................................................. 17 11/16 9 33/64
FISCAL YEAR ENDING DECEMBER 31, 1998
- -----------------------------------------------------------------------------------------------
First Quarter (through March 27, 1998)......................................................... 26 3/32 14 33/64
</TABLE>
The last reported sale price of the Common Stock on the Nasdaq National
Market on March 27, 1998 was $26.09 per share. As of March 16, 1998, there were
155 holders of record of the Company's Common Stock.
The Company has never paid cash dividends on its Common Stock and has no
intention of paying cash dividends in the foreseeable future. The Company
anticipates that all future earnings, if any, generated from operations will be
retained by the Company to develop and expand its business. Any future
determination with respect to the payment of dividends will be at the discretion
of the Board of Directors and will depend upon, among other things, the
Company's operating results, financial condition and capital requirements, the
terms of then-existing indebtedness, general business conditions and such other
factors as the Board of Directors deems relevant. In addition, the Company's
existing revolving credit facility prohibits the payment of cash dividends
without the lender's consent.
Since inception, the Company has issued and sold the following unregistered
securities, which amounts have been adjusted to reflect the Stock Split:
1. On March 10, 1998, the Registrant issued 1,353,000 shares of its
Common Stock in exchange for all of the outstanding capital stock of T-One
Corp. in a transaction valued at $25,080,000.
2. On November 30, 1997, the Registrant issued 849,298 shares of Common
Stock in exchange for all of the outstanding capital stock of LD Services,
Inc. in a transaction valued at approximately $13,930,569.
3. As of March 31, 1997, the Registrant had issued 18,450,000 shares of
Common Stock pursuant to direct issuances to employees in consideration for
services and advances provided by such employees for an aggregate purchase
price of approximately $1,103,000.
4. On February 23, 1996, the Registrant issued and sold 2,049,979
shares of Common Stock to a group of six investors for an aggregate purchase
price of $1,500,000.00.
5. On July 12, 1996, the Registrant issued and sold 1,874,532 shares of
Common Stock to Gotel Investments Ltd. for an aggregate purchase price of
$4,068,651.00.
6. On July 25, 1996, the Registrant issued and sold 2,802,446 shares of
Series A Preferred Stock to a group of twenty-two investors for an aggregate
purchase price of $7,500,003.51.
7. Since inception from time to time, as of February 28, 1998, the
Registrant has granted to employees, directors and consultants options to
purchase an aggregate of approximately
27
<PAGE>
4,798,000 shares of Common Stock pursuant to stock option agreements and the
Registrant's stock option plans.
The sales and issuances described above were deemed to be exempt from
registration under the Securities Act in reliance upon Section 4(2) thereof, as
transactions by an issuer not involving any public offering, or in reliance upon
the exemption from registration provided by Rule 701 promulgated under the
Securities Act. In addition, the recipients of securities in each such
transaction represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof and appropriate legends were affixed to the share
certificates issued in such transactions. All recipients had adequate access,
through their relationships with the Registrant, to information about the
Registrant.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH "SELECTED
CONSOLIDATED FINANCIAL DATA" AND THE CONSOLIDATED FINANCIAL STATEMENTS AND THE
NOTES THERETO CONTAINED ELSEWHERE IN THIS FORM 10-K. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS, AS DEFINED IN SECTION 27A OF THE SECURITIES ACT AND
SECTION 21E OF THE EXCHANGE ACT, THAT INVOLVE RISKS AND UNCERTAINTIES. STAR'S
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-
LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT LIMITED TO
THOSE DISCUSSED IN "RISK FACTORS" AND ELSEWHERE IN THIS FORM 10-K. SEE "RISK
FACTORS --FORWARD-LOOKING STATEMENTS."
OVERVIEW
The Company is an emerging multinational carrier focused primarily on the
international long distance market. The Company offers highly reliable, low-cost
switched voice services on a wholesale basis, primarily to U.S.-based long
distance carriers. STAR provides international long distance service to
approximately 220 countries through its flexible network comprised of various
foreign termination relationships, international gateway switches, leased and
owned transmission facilities and resale arrangements with other long distance
providers.
The Company installed its first international gateway switch in Los Angeles
in June 1995 and initially recognized wholesale revenues in August 1995. A
significant portion of the Company's revenues in 1994 and 1995 were generated by
the commercial operations of LDS.
REVENUES. Most of the Company's revenues are generated by the sale of
international long distance services on a wholesale basis to other, primarily
domestic, long distance providers. The Company records revenues from the sale of
long distance services at the time of customer usage. The Company's agreements
with its wholesale customers are short-term in duration and the rates charged to
customers are subject to change from time to time, generally with five days
notice to the customer.
COSTS OF SERVICES. The Company has pursued a strategy of attracting
customers and building calling volume and revenue by offering favorable rates
compared to other long distance providers. The Company continues to lower its
costs of services by (i) expanding the Company's owned network facilities, (ii)
continuing to utilize the Company's sophisticated information systems to route
calls over the most cost-effective routes and (iii) leveraging the Company's
traffic volumes and information systems to negotiate lower variable usage-based
costs with domestic and foreign providers of transmission capacity.
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Costs of services include those costs associated with the transmission and
termination of international long distance services. Currently, a majority of
transmission capacity used by the Company is obtained on a variable, per minute
basis. As a result, some of the Company's current costs of services is variable.
The Company's contracts with its vendors provide that rates may fluctuate, with
rate change notice periods varying from five days to one year, with certain of
the Company's longer term arrangements requiring the Company to meet minimum
usage commitments in order to avoid penalties. Such variability and the short-
term nature of many of the contracts subject the Company to the possibility of
unanticipated cost increases and the loss of cost-effective routing
alternatives. Included in the Company's costs of services are accruals for rate
and minute disputes and unreconciled billing differences between the Company and
its vendors. Each quarter management reviews the costs of services accrual and
adjusts the balance for resolved items. Costs of services also include fixed
costs associated with the leasing of network facilities.
The Company intends to begin providing international long distance services
to commercial customers in certain European countries in the second half of
1998. STAR began providing long distance service to commercial markets in the
U.S. with its acquisition of LDS in November 1997. STAR believes that traffic
from commercial customers has the potential to generate higher gross margins
than wholesale traffic. STAR also expects, however, that an expansion into this
market will also increase the risk of bad debt exposure and lead to higher
overhead costs. Information related to wholesale and commercial revenues and
operations will be reported in future Exchange Act filings made by STAR in
accordance with Financial Accounting Standards Board Statement No. 131.
Prices in the international long distance market have declined in recent
years and, as competition continues to increase, STAR believes that prices are
likely to continue to decline. Additionally, STAR believes that the increasing
trend of deregulation of international long distance telecommunications will
result in greater competition, which could adversely affect STAR's revenue per
minute and gross margin. STAR believes, however, that the effect of such
decreases in prices will be offset by increased calling volumes and decreased
costs.
OPERATING EXPENSES. Selling, general and administrative expenses consist
primarily of personnel costs, depreciation and amortization, tradeshow and
travel expenses and commissions and consulting fees, as well as an accrual for
bad debt expense. These expenses have been increasing over the past year, which
is consistent with STAR's recent growth, accelerated expansion into Europe, and
investment in systems and facilities. The Company expects this trend to
continue, and to include, among other things, a significant increase in
depreciation and amortization. Management believes that additional selling,
general and administrative expenses will be necessary to support the expansion
of the Company's network facilities, its sales and marketing efforts and STAR's
expansion into commercial markets.
FOREIGN EXCHANGE. The Company's revenues and cost of long distance services
are sensitive to foreign currency fluctuations. The Company expects that an
increasing portion of the Company's revenues and expenses will be denominated in
currencies other than U.S. dollars, and changes in exchange rates may have a
significant effect on the Company's results of operations.
FACTORS AFFECTING FUTURE OPERATING RESULTS. The Company's quarterly
operating results are difficult to forecast with any degree of accuracy because
a number of factors subject these results to significant fluctuations. As a
result, STAR believes that period-to-period comparisons of its operating results
are not necessarily meaningful and should not be relied upon as indications of
future performance.
The Company's revenues, costs and expenses have fluctuated significantly in
the past and are likely to continue to fluctuate significantly in the future as
a result of numerous factors. The Company's revenues in any given period can
vary due to factors such as call volume fluctuations, particularly in regions
with relatively high per-minute rates; the addition or loss of major customers,
whether through competition, merger, consolidation or otherwise; the loss of
economically beneficial routing options for the termination of STAR's traffic;
financial difficulties of major customers; pricing pressure resulting from
increased
29
<PAGE>
competition; and technical difficulties with or failures of portions of STAR's
network that impact STAR's ability to provide service to or bill its customers.
STAR's cost of services and operating expenses in any given period can vary due
to factors such as fluctuations in rates charged by carriers to terminate STAR's
traffic; increases in bad debt expense and reserves; the timing of capital
expenditures, and other costs associated with acquiring or obtaining other
rights to switching and other transmission facilities; changes in STAR's sales
incentive plans; and costs associated with changes in staffing levels of sales,
marketing, technical support and administrative personnel. In addition, STAR's
operating results can vary due to factors such as changes in routing due to
variations in the quality of vendor transmission capability; loss of favorable
routing options; the amount of, and the accounting policy for, return traffic
under operating agreements; actions by domestic or foreign regulatory entities;
the level, timing and pace of STAR's expansion in international and commercial
markets; and general domestic and international economic and political
conditions. Further, a substantial portion of transmission capacity used by the
Company is obtained on a variable, per minute and short term basis, subjecting
the Company to the possibility of unanticipated price increases and service
cancellations. Since STAR does not generally have long term arrangements for the
purchase or resale of long distance services, and since rates fluctuate
significantly over short periods of time, STAR's gross margins are subject to
significant fluctuations over short periods of time. The Company's gross margins
also may be negatively impacted in the longer term by competitive pricing
pressures.
RECENT ACQUISITIONS AND DEVELOPMENTS
The Company has recently acquired or entered into agreements to acquire the
following companies and has taken the following actions:
- L.D. SERVICES, INC. On November 30, 1997, the Company acquired LDS,
certain non-operating entities and majority ownership in another entity
for approximately 849,000 shares of Common Stock in a transaction
accounted for as a pooling of interests. The Company's audited financial
statements have been restated to include LDS' historical performance for
all relevant periods. The commercial business of LDS has historically had
higher gross margins and higher selling, general and administrative
expenses and operating costs than the Company's wholesale operations. As
the Company integrates and expands the commercial accounts of LDS, such
increase in operations may affect the Company's future operating margins.
In 1997, LDS settled disputes with the California PUC and with the
District Attorney of Monterey, California. The resulting payments and
restrictions on LDS' activities adversely affected its 1997 operating
results. See "Business--Government Regulation--Actions Against LDS."
- T-ONE CORP. On March 10, 1998, the Company acquired T-One for 1,353,000
shares of Common Stock in a transaction accounted for as a pooling of
interests. Consistent with applicable accounting standards, as of the date
of this Prospectus, the Company's audited financial statements have not
been restated to include T-One's historical performance. For the fiscal
year ended December 31, 1997, T-One had revenues of $30.4 million, gross
profit of $1.8 million, selling, general and administrative expenses of
$1.5 million and net income of $0.2 million. See Note 14 of Notes to
Consolidated Financial Statements.
- UNITED DIGITAL NETWORK, INC. On November 19, 1997, the Company entered
into an agreement to acquire UDN in a transaction to be accounted for as a
pooling of interests. The acquisition of UDN is subject to approval by
UDN's stockholders and to various regulatory approvals. Assuming the
receipt of all necessary approvals, management expects to consummate the
UDN acquisition in the second quarter of 1998 for approximately 800,000
shares of Common Stock. In connection with the UDN acquisition, STAR has
loaned an aggregate of $4.5 million to UDN. The Company's financial
statements have not been restated to reflect the acquisition of UDN. Based
solely on information provided by UDN to STAR, which has not been
independently verified by STAR, for the nine month period ended January
31, 1998, UDN had revenues of $23.9 million and a net loss of
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<PAGE>
$6.5 million. STAR believes that, because UDN operates in the commercial
market, its higher gross margins and operating costs will have an impact
on the Company's margins upon consummation of the merger and on a
going-forward basis once STAR's operating results are restated to include
UDN's historical performance. UDN's Common Stock trades on the Vancouver
Stock Exchange under the symbol UDN.
- On March 24, 1998, the Company filed a Registration Statement on Form S-1
(Registration No. 333-48559) registering 6,670,000 shares of Common Stock
to be sold by the Company (the "Offering"). The Company also granted the
Underwriters a 30-day option to purchase up to 1,050,000 additional shares
of Common Stock solely to cover over-allotments, if any. The Company
intends to use the proceeds from the Offering for capital expenditures,
working capital and general corporate purposes.
- STOCK SPLIT. On March 31, 1998, the Company will give effect to the Stock
Split with payment to the holders of the shares of Common Stock
outstanding on February 20, 1998 a stock dividend equal to 1.05 shares of
Common Stock for each such outstanding share.
RESULTS OF OPERATIONS
The following table sets forth certain selected items in the Company's
statements of operations as a percentage of total revenues for the periods
indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Revenues.......................................................................... 100.0% 100.0% 100.0%
Costs of services................................................................. 68.9 86.4 86.5
--------- --------- ---------
Gross profit...................................................................... 31.1 13.6 13.5
Operating expenses:
Selling, general and administrative expenses.................................... 21.8 14.4 9.4
Depreciation and amortization................................................... 0.4 0.5 1.1
--------- --------- ---------
Total operating expenses........................................................ 22.2 14.9 10.6
Income (loss) from operations..................................................... 8.9 (1.3) 2.9
--------- --------- ---------
Income (loss) before provision for income taxes................................... 8.7 (1.5) 2.3
Provision for income taxes........................................................ 0.1 0.3 0.8
--------- --------- ---------
Net income (loss)................................................................. 8.6% (1.8)% 1.5%
--------- --------- ---------
--------- --------- ---------
</TABLE>
YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES. Revenues increased 58.1% to $376.2 million in 1997 from $238.0
million in 1996. Wholesale revenues increased to $348.7 million from $208.1
million, with minutes of use increasing to 863.3 million minutes in 1997, as
compared to 479.7 million minutes of use in the prior year. This increase
reflects an increase in the number of wholesale customers from 84 in 1996 to 105
at the end of 1997, as well as an increase in usage by existing customers. The
average rate per minute of usage for wholesale customers declined from $0.43
cents per minute in 1996 to $0.40 cents per minute in 1997, reflecting the
change in country mix to include a larger proportion of lower rate per minute
countries as well as lower prices on competitive routes. Taking into account the
acquisition of T-One, on a pro forma basis, revenues in 1997 would have been
$406.6 million, an increase of 56.1% from $260.4 million in 1996.
Commercial revenues decreased to $27.5 million in 1997 from $29.9 million in
1996 reflecting the termination of the LDS customer base in California due to
the 1997 settlement entered into by LDS with
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each of the California PUC and the District Attorney of Monterey, California.
See "Business--Governmental Regulation--Actions Against LDS."
GROSS PROFIT. Gross profit increased 57.3% to $51.0 million in 1997 from
$32.4 million in 1996. Wholesale gross profit increased to $39.8 million in 1997
from $19.7 million for 1996 and wholesale gross margin increased to 11.4% from
9.4%, respectively. Wholesale gross profit expanded during 1997 as traffic was
increasingly routed over the Company's proprietary international network.
Commercial gross profit decreased 11.8% to $11.2 million in 1997 from $12.7
million in 1996 and commercial gross margin declined to 40.7% from 42.6% over
such periods, reflecting declining prices in the competitive long distance
market. As STAR migrates the LDS commercial customer base onto the Company's
network, LDS' cost of commercial long distance services is expected to decline.
Taking into account the acquisition of T-One, on a pro forma basis, gross profit
in 1997 would have been $52.8 million, an increase of 56.4% over gross profit of
$33.7 million in 1996.
SELLING, GENERAL AND ADMINISTRATIVE. In 1997, selling, general and
administrative expenses increased 3.1% to $35.4 million, from $34.3 million in
1996. Wholesale selling, general and administrative expenses increased to $26.0
million in 1997 from $24.1 million in 1996, but decreased as a percentage of
wholesale revenues to 7.5% from 11.6% over the comparable periods. Total
expenses increased year to year in absolute dollars as STAR expanded its
proprietary international network and employee base. Included in the 1996
selling, general and administrative expense was $11.6 million in reserves and
write-offs against deposits and accounts receivable related to bad debts from
two customers. Commercial selling, general and administrative expenses decreased
to $9.4 million in 1997 from $10.2 million in 1996 and remained flat as a
percentage of commercial revenues at approximately 34.1%. The Company expects
selling, general and administrative expenses to expand in absolute dollars and
as a percentage of revenues in fiscal year 1998, as the Company expands its
network and employee base and in connection with the Company's entry into the
commercial market.
DEPRECIATION. Depreciation increased to $4.2 million for 1997 from $1.2
million for 1996, and increased as a percentage of revenues to 1.1% from 0.5% in
the prior period. Depreciation increased as a result of STAR's continuing
expansion of its proprietary international network which includes purchases of
switches, submarine cable and leasehold improvements associated with switch
sites. STAR expects depreciation expense to increase as the Company continues to
expand its global telecommunications network.
OTHER INCOME (EXPENSE). Other expense, net, increased to $2.6 million in
1997 from $552,000 in 1996. This increase is primarily due to interest expense
of $1.6 million incurred under various capital leases and bank lines of credit
and a legal settlement and associated expenses of $1.7 million. The legal
settlement relates to the dispute settled by LDS with the California PUC and the
District Attorney of Monterey County. See "Business--Governmental
Regulation--Actions Against LDS." Interest income earned on short-term
investments increased to $492,000 in 1997 from $110,000 in 1996 due to interest
earned on the proceeds of the Company's June 1997 initial public offering.
PROVISION FOR INCOME TAXES. The provision for income taxes increased to
$2.9 million in 1997 from $592,000 in 1996, primarily due to the increase in
profitability of the Company.
YEARS ENDED DECEMBER 31, 1996 AND 1995
REVENUES. Revenues increased 414.2% to $238.0 million in 1996 from $46.3
million 1995. Wholesale revenues increased to $208.1 million in 1996 from $16.1
million in 1995, with minutes of use increasing to 479.7 million in 1996, as
compared to 38.1 million minutes of use in the prior year. The increase in
wholesale revenue resulted from STAR's commencement of operations as an
international long distance carrier, an increase in the number of customers as
compared to the prior year and an increase in minutes of wholesale traffic from
new and existing customers. The increase in traffic is also attributable to an
increase in the number of routes with favorable rates that STAR was able to
offer to customers.
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<PAGE>
Commercial revenues decreased to $29.9 million in 1996 from $30.2 million in
1995 due to a decrease in the rate per minute charged, which was partially
offset by an increase in the number of minutes sold. Taking into account the
acquisition of T-One, on a pro forma basis revenues would have been $260.4
million in 1996, an increase of 341.9% from $58.9 million in 1995.
GROSS PROFIT. Gross profit increased 125.3% to $32.4 million for 1996 from
$14.4 million in 1995. Wholesale gross profit increased to $19.7 million in 1996
from $1.8 million for 1995. Wholesale gross margin decreased to 9.4% in 1996
from 11.0% in 1995, reflecting the change from STAR's prior consulting business
to operating as an international long distance carrier. Gross profit was
positively impacted during 1996 by the negotiation of lower rates on routes with
significant traffic, and negatively impacted by increases in traffic on routes
with lower margins. Commercial gross profit increased to $12.7 million in 1996
from $12.6 million in 1995 with gross margin increasing to 42.6% from 41.8%,
respectively. The gross profit from commercial services expanded as costs
associated with the local exchange carriers declined. Taking into account the
acquisition of T-One, on a pro forma basis, gross profit in 1996 would have been
$33.7 million, an increase of 130.0% from $14.7 million in 1995.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 240.4% to $34.3 million in 1996 from $10.1 million in 1995.
Wholesale selling, general and administrative expenses increased to $24.1
million in 1996 from $2.1 million in 1995, and decreased as a percentage of
revenues to 11.6% from 12.8% in the prior period. Selling, general and
administrative expenses increased between periods as STAR increased its employee
base and incurred payroll, employee benefits, commission and related expenses.
STAR also established a reserve for doubtful accounts to reflect its
significantly higher revenue levels and invested in sales and marketing
activities, including tradeshows and travel. Hi-Rim and CCI, two of STAR's major
customers in 1996, informed STAR that they were experiencing financial
difficulties and would be unable to pay in full outstanding accounts receivable.
As a result, the full amount of the approximately $10.8 million owed to STAR by
Hi-Rim and CCI as of December 31, 1996 which was not subsequently collected or
for which no offsetting value was received, was written off or reserved in 1996.
In addition, STAR wrote-off $820,000 of intangible assets relating to CCI.
Commercial selling, general and administrative expenses increased to $10.2
million in 1996 from $8.0 million in 1995 reflecting higher operating costs.
DEPRECIATION. Depreciation increased to $1.2 million for 1996 from $186,000
for 1995, an increase as a percentage of revenues to 0.5% from 0.4% in the prior
period. Depreciation increased as a result of STAR's purchase of switches and of
the operating equipment and leasehold improvements associated with its Los
Angeles and New York switching facilities. Depreciation expense will increase as
STAR expands its ownership of switching and transmission facilities through
purchase or use of capital leases.
OTHER INCOME (EXPENSE). Other expense, net, increased to $552,000 in 1996
from $75,000 in 1995. This increase is primarily due to a $100,000 legal
settlement in the second quarter of 1996 as well as $601,000 in interest expense
incurred under various bank and stockholder lines of credit. This increase was
offset by $110,000 in interest income on short-term investments and cash
equivalents primarily from funds raised in private placements of equity
securities during the first three quarters of 1996.
PROVISION FOR INCOME TAXES. Through December 31, 1995, STAR had elected to
be taxed as an S-Corporation for both federal and state income tax purposes and
thus was only subject to 1.5% tax on taxable income for state purposes. LDS was
an S-Corporation through the date of the merger on November 30, 1997. The pro
forma provision for income taxes, assumes that both STAR and LDS were
C-Corporations for all periods presented. During 1996, the historical provision
for income taxes increased to $592,000 as a result of the reserve of $2.9
million of the net deferred tax asset.
33
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, STAR had cash and cash equivalents of approximately
$1.5 million, short-term investments of $18.6 million and a working capital
surplus of $15.8 million. In June 1997, the Company completed an initial public
offering of 9.4 million shares of Common Stock of which approximately 8.1
million shares were sold by the Company and approximately 1.3 million shares
were sold by certain selling stockholders. The net proceeds to the Company
(after deducting underwriting discounts and offering expenses) from the sale of
such shares of Common Stock were approximately $30.9 million. As of December 31,
1997, the Company had used the proceeds from the offering to repay indebtedness
of $14.2 million, to purchase switching and transmission related equipment and
to finance the Company's operations in the U.K.
As of December 31, 1997, STAR had no funds outstanding on its $25 million
revolving line of credit, which bears interest at a rate of the bank's cost of
funds plus 175 basis points and expires on July 1, 1999. However, the line of
credit is reduced by outstanding letters of credit in the amount of $4.9
million.
STAR generated net cash from operating activities of $10.1 million in 1997,
primarily from net income plus depreciation and amortization, while using $3.4
million in 1996. The Company's investing activities used cash of approximately
$29.6 million during 1997 primarily resulting from capital expenditures and the
investment of the proceeds from the initial public offering in marketable
securities, while using $9.8 million in 1996. The Company's financing activities
provided cash of approximately $19.3 million during 1997 primarily from the sale
of Common Stock and borrowings under lines of credit, offset by repayments under
various lines of credit, while providing $14.7 million in 1996.
STAR had capital lease obligations of $13.6 million, and $0.8 million in
term loans, relating to its switching facilities and operating equipment. STAR
anticipates making capital expenditures of approximately $80.0 million over the
next 12 months to expand its global network. STAR believes that the proceeds
from the Offering and cash generated from operations, as well as funding under
its bank line of credit, will satisfy STAR's current liquidity needs.
Nevertheless, as the Company continues to expand its network facilities and
pursues its strategy of growth through acquisition, the Company's liquidity
needs may increase, perhaps significantly, which could require the Company to
seek such additional financing or the expansion of its borrowing capacity under
current or new lines of credit. As appropriate, STAR will use capital lease
financing or raise additional debt or equity capital to finance new projects or
acquisitions. The Company had foreign currency contracts outstanding at December
31, 1997 in the notional amount of $6.3 million. See Note 2 of Notes to
Consolidated Financial Statements.
YEAR 2000 COMPLIANCE. The Company has made a concerted effort to insure
that the software components of its information and billing systems are Year
2000 compliant. As such, management believes that, after January 1, 2000, the
Company will be able to continue to accurately track and bill calls. At the same
time, it is likely that the operations of a number of the Company's customers
and vendors rely on software that is not Year 2000 compliant.
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<PAGE>
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K/A
to be signed on its behalf by the undersigned, thereunto duly authorized in the
City of Santa Barbara, State of California, on the 7th day of April, 1998.
<TABLE>
<S> <C> <C>
STAR TELECOMMUNICATIONS, INC.
By: /s/ KELLY D. ENOS
-----------------------------------------
Kelly D. Enos
Chief Financial Officer
</TABLE>
II-1
